Conversion to Organic Farm Management: A Dynamic Programming

Approach

Timothy A. Delbridge1 and Robert P. King

1

1Department of Applied Economics, University of Minnesota, St. Paul, Minnesota, USA.

Selected Poster prepared for presentation at the Agricultural & Applied Economics

Association’s 2012 AAEA Annual Meeting,

Seattle, Washington, August 12-14, 2012.

Copyright 2012 by Delbridge and King. All rights reserved. Readers may make verbatim copies of

this document for non-commercial purposes by any means, provided this copyright notice appears on

all such copies.

Introduction

Conversion to Organic Farm Management:

A Dynamic Programming Approach

Timothy A. Delbridge* and Robert P. King

Department of Applied Economics, University of Minnesota

*Email: delbr002@umn.edu

Results: Transition Thresholds

In general, organic transition is more attractive when conventional returns are low.

There is also a range of conventional returns which results in both organic and

conventional farms maintaining their current system. Then, at higher levels of

conventional returns, it becomes profitable to farm conventionally even if the farm is

already certified organic (i.e. reverse transition). For farm size scenario #1, organic

transition will be started at higher levels of conventional returns than the other farm

size scenarios, and reverse transition will occur only at very high levels of

conventional returns. A $50 per acre subsidy received only during transition years

results in a narrowing of the band of inaction for all farm sizes while a $50 per acre

subsidy on organically managed land (including transition years) shifts the band of

inaction to higher levels of conventional returns (i.e. encourages transition). When

receipt of both the transition and organic subsidies is possible, the band of inaction

widens and shifts right. That is, in this scenario, there is only a small range of very

high conventional returns that will result in reverse transition.

Methods (cont.)

Based on updated results from Delbridge et al. (2011b) we consider

three farm size scenarios (See table right). These scenarios reflect

differences in organic and conventional farm size due to the differing

labor and management requirements of the two systems. Constant

absolute risk aversion is assumed with a coefficient of 0.000005, which

represents a risk premium of approximately 25% for the mid-sized farm

scenario. Overhead costs for both systems are averages from similar

organic and conventional farms in Minnesota (FINBIN, 2011).

Previous studies have found that organic cropping

systems have greater per-acre returns than conventional

rotations in the Midwest (Lockeretz et al. 1978; Delate et

al. 2003; Chavas, Posner, and Hedtcke 2009; Delbridge

et al. 2011a). Noting that relatively few conventional crop

farms have adopted organic management despite these

higher net returns, other studies have attempted to

model the decision to undertake farm conversion (Acs et

al. 2009; Wossink and Kuminoff 2010). This study

advances this literature by using long term trial data on

organic and conventional crop rotations and recent

results on the differing management requirements for

these two systems (Delbridge et al. 2011b), to more

realistically model the decision to convert to organic crop

production in the Midwestern U.S.

This study uses 18 years of agricultural trial data along

with empirical whole-farm cost data to model the

relationship between organic, conventional, and

transitional returns to crop management and investigate

the degree to which policy and farm size affect the rate

of organic conversion. Specifically, our objectives are:

1. Determine the steady state probability of organic

transition for various farm sizes.

2. Investigate how the likelihood of transition might be

affected by incentives for transitioning farmers or fully

organic farmers.

3. Compare steady state outcomes with short-run

transition probabilities for different “starting points”

Conclusions Even though the 4 year organic rotation has a higher average net return than the conventional 2 year system, the costly transition period and the

uncertainty of future returns lessen the probability of a farm transitioning to the more profitable organic system. When conventional returns are

high, as they have been in recent years, not only does the probability of organic transition decrease, but the optimal decision can be to abandon

organic management. Potential subsidy policies to encourage organic transition are shown to be effective, though simply subsidizing farms during

the 3-yr transition has much less impact than a subsidy on all organically managed acres.

1. Acs, S., P. Berensten, R. Huirne, and M. van Asseldonk. 2009. Effect of yield and price risk on conversion from conventional to organic farming. Australian Journal of Agricultural and Resource Economics. 53:

393-411.

2. Chavas, J-P., J.L. Posner, and J.L. Hedtcke. 2009. Organic and conventional production systems in the Wisconsin integrated cropping systems trial: II. Economic and risk analysis 1993-2006. Agron. J. 101:288-

295.

3. Delate, K., M. Duffy, C. Chase, A. Holste, H. Friedrich, and N. Wantate. 2003. An economic comparison of organic and conventional grain crops in a long-term agroecological research (LTAR) site in Iowa. Am. J.

of Altern. Agric. 18:59-69.

4. Delbridge, T.A., J.A. Coulter, R.P. King, C.C. Sheaffer, and D.L. Wyse. 2011a. Economic Performance of Long-Term Organic and Conventional Cropping Systems in Minnesota. Agron. J. 103:1372-1382.

5. Delbridge, T.A., C. Fernholz, R.P. King, and W. Lazarus. 2011b. A Whole-Farm Profitability Analysis of Organic and Conventional Cropping Systems. Available at:

http://ageconsearch.umn.edu/bitstream/103790/2/Delbridge%20AAEA%202011%20v2.pdf.

6. Kuminoff, N.V., and A. Wossink. 2010. Why isn’t more U.S. farmland organic? Journal of Agricultural Economics. 61(2):240-258.

7. Lockeretz, W., G. Shearer, and D.H. Kohl. 1981. Organic Farming in the Corn Belt. Science. 211:540-547.

8. Miranda M.J., and P. Fackler. Applied Computational Economics and Finance. The MIT Press, 2002.

Results: Steady State Transition

Under all three subsidy scenarios, farm size #1 (in which the organic and conventional farms are both 320

acres) has a higher probability of transition than the other farm size scenarios. Farm size scenarios #2 and

#3 have nearly equal transition probabilities. The net effect of the transition subsidy in the steady state is to

encourage transition, though the effect is small compared to that of a subsidy on all organically managed

acres. Including both of the subsidies at the same time, which is equivalent to a $100 per acre subsidy during

transition years and a $50 per acre subsidy thereafter, has an effect substantially larger than the sum of the

individual subsidy effects.

Results: Short-term Transition

Unlike the probability of organic transition in the steady state, the probability of transition in the short-run (10 years) is affected by the initial

value of the conventional system’s returns. Because higher conventional returns make organic transition less attractive, the transition

probabilities decrease as the model’s initial conventional return value increases. Just as in the long-run, short-run transition probabilities

increase with the transition and organic subsidies, though the impact of each depends on the initial value of conventional returns. For all farm

sizes, the higher the initial value, the smaller the impact of the subsidy. For example, for farm size #2, the organic subsidy increases the

probability of transition by 0.18 when the initial return level is $450 but by only 0.09 when the initial level is $750. As in the steady state we see

that for all three farm size scenarios, the transition subsidy has a much stronger effect in conjunction with the organic subsidy than alone.

Objectives

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1993 1998 2003 2008

Org

ani

c : C

onv

ent

iona

l Ra

tio

Gross Returns to Organic and Conventional Rotations

2006 Prices

2007 Prices

2008 Prices

2009 Prices

2010 Prices

Crop rotation Total Crop Acres

Size #1 Size #2 Size #3

Organic 4-yr 320 560 800

Conventional 2-yr 320 880 1,360

Methods Net returns to management are calculated for a four-

year organic crop rotation (corn-soybean-oat/alfalfa-

alfalfa) and a two-year conventional rotation (corn-

soybean) using yield and management data from a side-

by-side cropping systems trial and 5 years of recent

commodity prices. Trial yields of organic corn and

soybean are reduced by 25% to more closely reflect

state average yields. We use these data series to model

the stochastic processes underlying net returns to

conventional and organic crop management.

Conventional returns are modeled as a mean reverting

stochastic process while organic and transitional returns

are modeled as linear functions of conventional returns.

We frame the transition decision as a dynamic programming problem that identifies an optimal conversion policy that is

sensitive to current cropping returns. The model is solved using dynamic programming software developed by Miranda and

Fackler (2002). In contrast to the comparison of each system’s net present value, this method allows for the role of

uncertainty and sunk costs (i.e. low transitional returns) in the decision of whether or not to convert. The model also allows

for two-way conversion to account for the fact that organic farmers can, and do, revert to conventional crop management

under some market conditions.

$450 $600 $750

Starting value of the conventional system return ($/acre)

Probability of transition within 10 years without

subsidies

0%10%20%30%40%50%60%70%80%90%

100%

$450 $600 $750

Farm Size 1

Farm Size 2

Farm Size 3

Starting value of the conventional

system return ($/acre)

$450 $600 $750

Starting value of the conventional system return ($/acre)

Probability of transition within 10 years given a

$50 organic subsidy

0%10%20%30%40%50%60%70%80%90%

100%

$450 $600 $750

Starting value of the conventional system return ($/acre)

Probability of transition within 10 years given both

subsidies

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

No subsidy Transition subsidy Organic subsidy Both subsidies

Probability of Transition to Organic System (steady state)

Farm Size 1

Farm Size 2

Farm Size 3

Probability of transition

within 10 years given a

$50 transition subsidy

Both subsidiesOrganic subsidyTransition subsidyNo subsidy

Both subsidiesOrganic subsidyTransition subsidyNo subsidy

Both subsidiesOrganic subsidyTransition subsidyNo subsidy

$300 $400 $500 $600 $700 $800

Farm Size1

Farm Size2

Farm Size3

Critical Values of Conventional Net Returns

Organic management Continue with current system Conventional management

We consider four policy scenarios which represent different levels of support for

organic and transitioning farmers. In addition to the baseline scenario in which no

subsidies are received by either system, there is a transition subsidy of $50 per acre.

This roughly mimics programs such as USDA’s EQIP program, which helps offset the

costs of conservation investments. The organic subsidy scenario, which is $50 per

acre for all land managed organically (including transition acres) is roughly similar to

conservation programs like CSP which provides an ongoing payment for eco-system

services. Finally, we consider a scenario in which both subsidies are received.