DRI-216 for week of 12-15-13: The High Cost of Organic Farming

An Access Advertising EconBrief:

The High Cost of Organic Farming

One of the most venerable – and venerated – principles of free-market economics is consumer sovereignty. In any human society, somebody has to decide what goods and services are produced and in what quantities. Superficially, it would seem that the “what” and “how much” questions are answered by owners and managers of business firms. But it is really consumers who answer the questions with their marketplace purchase decisions. That may be the most distinctive feature separating market economies from alternative forms of economic organization. Producers may propose, but consumers dispose. Businesses nominally decide what to produce, but consumers reward the businesses that produce desirable goods and shun those that produce undesirable ones, thereby indirectly controlling production. Producers dictate the size of production runs, but some goods fly off the shelves while others squat there until evicted; consumer purchases really determine the quantities produced.

There is another side to the coin of consumer sovereignty, though. This underside is seldom exposed, but nonetheless integral to a smoothly functioning market. In making their purchase decisions, consumers react to the prices offered by producers. The logic of free-market efficiency assumes that the prices chosen by producers bear an appropriate relationship to the costs of production. Specifically, the short-run equilibrium price will cover variable costs and the long-run equilibrium price will cover total costs. At all times, price will be equal to short-run marginal cost. Producers will not deliberately operate at a loss indefinitely.

Ordinarily, this correlative assumption is eminently reasonable. When the subject is environmentalism and health, however, reason flies out the window. And, like the baby accompanying the bath water, economic efficiency follows close behind.

The Organic Movement

Organic farming has been around for many decades. The general idea behind the movement is to produce agricultural output using only “natural” methods, eschewing synthetic chemicals found in staple agricultural inputs like pesticides, commercial fertilizers and antibiotics. The reason for avoiding substances not originating in nature is that they are (a) potentially harmful to humans because they are (b) not natural; e.g., originary in nature.

Until recently, organic farming was limited to a small cult following.  That is no longer true. Today, the demand for organic foods is strong. Naturally, this demand has enabled producers to specialize in producing organic output. The current (Winter 2013) issue of “WSJ.Money” offers an article by Charles Passy called “The New Gentleman Farmer.” The article’s subhead asks the provocative question: “Can the Wealthy Make a Living Growing Organic Food?”

The thrust of the author’s position is that quite a few wealthy people are choosing to start up and operate organic farms because “the nation is in the middle of an organic-food boom.” How do we know that? Well, organically produced steak – that is, beef raised using the organic methods described above – sells for up to $42 per pound in some locations. The price premium commanded by organic over non-organic goods that are otherwise close substitutes is the best index of their consumer popularity.

Some of these wealthy organic entrepreneurs as famous are as Oprah Winfrey, who owns and operates an organic vegetable farm in Hawaii. Many of them are as knowledgeable about business as George Malkemus (President of Manolo Blahnik) and Sandy Lerner (co-founder of Cisco Systems). The list of organic farmers is replete with attorneys, corporate executives and financial-asset brokers.

Demand for organic foods is strong. Prices are sky-high. Entrepreneurs are rich and highly business-savvy. So what’s up with that title – why in the world should there be a problem with making money in this business? Incredible as it seems, there is. Despite their impressive resumes, the one thing that most organic farmers fail to do is turn a profit. The fly in the ointment, possessing the bulk of a radiation-stoked mutant insect from a 1950s science-fiction movie, is the cost of producing organic foods.

The High Cost of Organic Methods

Why should organic farming generate costs high enough to overwhelm such a strong consumer demand? Consider the example of the Sandy Lerner’s cattle-raising operation. Cattle must be fed on grass rather than corn; the former is by far the more expensive option. Cattle must be put out to pasture, incurring labor and materials costs. The pasture itself must be tended, which produces further expense; substituting actual weeding for pesticide use substitutes labor for capital while increasing total cost. Cattle expend energy in the grazing process, causing weight loss. They are subjected to threats by predators or their peers. Grass can accumulate indigestible stems and even irritate the eyes of cattle. Treating these health problems with antibiotics violates the organic canon.

On the other hand, not treating cattle using best practices would seem to violate another prime organic canon; namely, humane treatment. This illustrates the Achilles heel of environmentalist philosophy, which pretends to substitute an objective, scientific standard for economics. Alas, there is no objective means for coping with tradeoffs and contradictions that arise when different strands of the standard conflict. Only the common denominator of money and the subjective scale of human preference can solve those kinds of problems without coercion and arbitrariness.

Beef production does not qualify for the traditional government subsidies – price supports, acreage allotments and such – provided to growers of grains, fibers and leaf. And indeed, organic versions of subsidized crops do tend to produce higher revenue than conventional versions. But crops like corn are problematic for the organic movement because too many strains have been genetically modified – another philosophical no-no within the movement.

The organic movement may be New Age, but it is also New Left. In order to qualify as truly organic, a producer must be certified. That implies both government (USDA) and private certification; the former attests to the physical attributes of the output and the latter to the sensitivity of the producer. The requirement of humane treatment forbids close confinement of cattle and requires provision of shelter and rest areas for livestock.

The effect of all this on costs is fearsome. Lerner estimates that her feed costs alone are “three to five times higher” than conventional feeds. Ever since the 1700s, agricultural productivity has been increased by scientific advances in machinery, fertilizers, pesticides, plant breeding, cultivation techniques, and soil conservation. Much of this science is foreclosed to the organic movement. In turn, this drastically limits the size and scope of organic farming – which puts a lid on its scale. But it is economies of scale that have kept farms and farmers in business over the last two centuries. Agricultural output consists predominantly of food and fiber. Although large and steady increases in productivity have driven productivity resolutely upward, people have not increased their consumption of food and clothing commensurately. After all, you can only eat so much food and wear so much clothing. Farmers’ could keep their heads above water only by reducing their costs commensurately with the increase in overall output. And only those farms that take full advantage of economies of scale can achieve these cost reductions.

The historical result of this inexorable historical evolution has been continuous reduction in the number of farms along with an increase in the average size of remaining farms. Today, the size distribution of U.S. farms shows a relatively small number of very large farms; these are the successful “factory farms” owned and run by corporate farming operations. The smaller “family farms” continue to dwindle in numbers and revenue. The median financial result for U.S. farms is a net loss of about $2,300 per farm. (In this case, the big difference between the mean and the median reflects the effect of the highly successful large operations.) At the bottom of this distribution are the vanity operations run by today’s “gentleman farmers,” the organic entrepreneurs.

The Mindset of Organic Farming

It is clear that organic farming today demands a special kind of farmer – the stupid kind. If that sounds rude, consider that it comes from Sandy Lerner herself, who describes organic farming as “farming stupid.” She concludes ruefully that “[organic] farming needs a 12-step program” to treat the addicts who populate it.

One management consultant speculates that “gentleman farmers go into it because it’s a bigger challenge than the business world they’ve been in.” The likelier explanation, though, is that organic entrepreneurs have drunk the same Kool-Aid as movement consumers. Interviews feature comments such as “I wanted to …raise the best possible food” and “we need to pay more attention to things that are real and tangible” and “as you begin to farm organically, you are getting in touch with the soil.”

Recall that these words fall from the mouths of hard-headed business leaders and legendary entrepreneurs. In their saner moments, they are morose and apologetic about their obsession. “How the hell do people do this for a living?” grouses bankruptcy attorney Randy Williams, whose organic chicken/goat/lettuce farm manages to lose only a few thousand dollars per year thanks to his careful product diversification. Speaking of which, real-estate broker Steve Kettelle has a catalogue boasting 35 products on a five-acre operation that manages to turn a small accounting profit. The term “accounting profit” refers to a distinction stressed by economists: if an owner-operated business fails to throw off sufficient profit to compensate the owner for the best alternative use of his or her labor time, it is not really earning a profit. According to Kettelle, translating his accounting profit into an hourly-wage equivalent “would probably [yield a] below minimum wage” result.

We cannot simply ascribe the anomaly of organic farming to mass schizophrenia. “Most [organic farmers] say they would like to see their operations succeed financially, if only to show the world that the farming methods they’ve embraced have broader merit” [emphasis added]. Presumably, this missionary zeal was absent from their previous successful ventures in businesses like Manolo Blahnik and Cisco. Sandy Lerner speaks reverently about wanting to be “a model for other small farms.” If producers in a free market succumbed to any obsession, it would presumably be to provide consumers with one or more desirable products. Why should entrepreneurs strive to be a model to other entrepreneurs – their competition? Outdo them, yes; earn their approval and emulation, no. This is the rhetoric of ideology, not markets.

The Economic Significance of Unprofitable Organic Farming

The economic significance of the anomaly in the market for organic food is lost on most people. The conventional thinking assumes that the only function of prices is to redistribute income and the only meaningful outcome of market activity is income distribution itself. Since the only visible adverse effect of the organic food anomaly is to lighten the wallets of some rich people, this seems no reason for regret. Consumers of organic foods get what they want; that’s a good thing, isn’t it?

Markets exist in order to uncover the truth. Humans didn’t invent markets for that purpose; markets evolved because they satisfied our wants in more primal and direct ways. The least celebrated but most important benefit of markets is to unearth information on both the supply and demand side of the market that would otherwise be prohibitively difficult or impossible to acquire. The information is subjective because it comes from inside the minds of billions of individual human beings.

Markets persist and thrive because the information they generate is true. Markets gradually reshape the subjective information fed into them into a form that approaches ever closer to objective truth. A mathematician would say that market outcomes approach objective truth asymptotically, never quite reaching it because the information itself is changing and being reshaped constantly, making objective truth the cognitive pot of gold at the end of the epistemological rainbow.

Consumers feed their wants and desires into the demand side of the market, yielding a trove of information otherwise unavailable to any central planner or government agency. Consumer demand is one side of the celebrated “Marshallian scissors,” the supply/demand diagram beloved of economics textbooks. The other side – the supply side – is pieced together using the costs of production generated by business firms. Supply, too, influences market price. Alfred Marshall’s famous dictum was that supply and demand operate like two blades of a pair of scissors in that each one is necessary to full function.

Markets tend to produce true outcomes because if a market price happens to be at variance with the truth, somebody can make money by acting on the non-compliance. And the cumulative effect of such actions will bring price back into conformity with truth. If a price is “too high” – that is, so far above costs that the rate of profit greatly exceeds the rate on the next-best investment of comparable risk – entrepreneurs can and will make money by redirecting resources to the sector of the high price. Those redirected resources will increase output in the sector, reducing the market price and lowering the rate of return until it eventually draws equal with that next-best alternative, the “opportunity cost” of capital or owner-supplied labor. (Formal economic theory – the Marshallian version of it, anyway – divides the response into a short-run reaction by existing firms within the industry and a long-run reaction featuring entry of new firms into the industry.)

The organic-food industry is an opposite case. Despite the price premium enjoyed by producers of organic products, the price is still “too low” to compensate producers for the stratospheric costs of production incurred. Ordinarily, producers would go out of business and stop producing output, reducing the supply of organic products and driving up their price. (This would also reduce the willingness of consumers to purchase those products.) The higher price would eventually increase the rate of return available to sellers of organic products until it equals the rate available in the next-best alternative investment of equal risk. There is a very good reason why this normally happens – producers do not want to go out of business because they cannot afford to. The old saying that “the knowledge that one is about to be hanged in the morning concentrates the mind wonderfully” applies particularly to producers who are losing money.

Organic foods are an exception because so many producers are rich dilettantes – so-called gentlemen farmers – who made their pile of money in conventional ways in garden-variety businesses. Now they are risking their own money by indulging their vanity in the organic-food business. They can afford to lose money, up to a point. They are willing to lose money to prove their point, at least for awhile. This explains why the normal rules of free-market analysis have been suspended and the organic-food market has been spared the usual market adjustment.

Should we shrug our shoulders and leave the rich dilettantes to their amusements, secure in the knowledge that it’s their money at risk and not ours? Yes and no.

“Yes” in the sense that we have no right to tell wealthy entrepreneurs what to do with their money. But “no” in the sense that we are affected by the organic-food anomaly, even though we cannot see or feel the effects directly.

Currently, participants in the organic-food market are living a lie – not merely a transitory lie of relatively minor magnitude as would be associated with free markets, but a major lie of indefinite duration. Producers are lying to consumers about the costs of producing organic foods and those lies are reflected in lower prices than would otherwise prevail. Every time consumers purchase an organic-food product, the price tells them that they are sacrificing x worth of alternative output. But in fact, the actual costs of producing the product dictate that x + y alternative output is being sacrificed. If consumers knew this, they would buy less organic food and less would be produced. This would allow consumers to benefit from more production of alternative goods. Unfortunately, consumers cannot know this because they have all they can handle just mastering the details of their own lives without having to become experts on production costs of the thousands of goods they buy. In effect, they are relying on producers to tell them the truth about production costs. (Few consumers realize the extent of this interdependence because few understand the workings of economics; one of the beauties of free markets is that we don’t have to become economists in order to benefit from them.)

The cost-of-production lie is not the only one being sustained by the current organic-food anomaly. The organic philosophy itself is a lie. It is based on a dishonest premise – that industrial civilization is unhealthy, dangerous and run by a few who benefit at the expense of the masses.

The pejorative use of “chemical” and glorification of “natural” substances have no scientific basis, despite their elevation to sacred practice in the organic movement. The human body is itself made up of chemicals. Natural substances can and do kill us, while synthetic chemicals are generally not merely benign but beneficial. Indeed, the motivation for synthesis was to create value for human beings, so we should expect this relationship to hold.

Pesticides are treated as unhealthy in the absolute sense. This is wrong. Humans have been harmed by accidental industrial exposures to pesticides at full strength, but not by ingestion of pesticide residues on foods. (Allergies are a possible and minor exception to this assertion, as they are to most exposures.) The first law of toxicology is “the dose makes the poison.”

Pollution is caused by the lack of free markets rather than by their incidence. Enforceable property rights are the best prophylactic against pollution and the best incentive toward cost-effective pollution abatement.

The history of agriculture over recent centuries is a history of increased productivity enabled by science and technology and midwived by free markets. The “green revolution” in scientific agriculture, including genetic modification of crop strains, has reduced famine and starvation to an unparalleled extent, aided and abetted by the grudging acceptance of free-market economics in the Third World.

Decades of research have failed to underpin the organic philosophy with a scientific basis. Until quite recently, organic foods were minor segment of the market. Production could only be financially maintained at extremely low levels. Thus, the organic market was a cottage industry and a large fraction of output was consumed by producers. Only now, with the advent of the gentleman farmer, can the financial lies of even moderately large-scale production be sustained.

The Discipline of the Free-Market System

The general belief is that free-market systems exert tyrannical control over us by forcing us to pursue money and material things at the expense of the finer things in life. This is a tragic misconception. By constantly encouraging us to make the most efficient use of the resources available to us, free markets free up our time and energies and create the wealth of goods that allow us to indulge our higher impulses.

The deference accorded to organic foods is a byproduct of the triumphal rise of environmentalism. That is another way of saying that it reflects the triumph of coercion over free markets and lies over truth.