Organic Certification & the Role of the Firm

Great story in Salon today about organic certification:
Is this the end of organic coffee? by Samuel Fromartz (subscription required)

Last month, the U.S. Department of Agriculture quietly released a ruling that alarmed organic certifiers and groups who work with third-world farmers. The decision tightens organic certification requirements to such a degree that it could sharply curtail the ability of small grower co-ops to produce organic coffee — not to mention organic bananas, cocoa, sugar and even spices.

The issue is basically this: to be certified as organic, a farm has to be inspected yearly so that its methods can be verified. Such inspections cost money. This isn’t a problem for large farms and plantations: the cost of a yearly inspection is trivial for them. But for small farms in the Third World, it’s a big problem. So the USDA regulations formerly allowed small forms to aggregate into collectives, and for inspections to be carried out on just a percentage of farms within the collective each year. The new USDA ruling changes that, and requires every farm to be inspected & certified individually.

So, small-time growers will either have to suffer substantial increases in their costs, which may price them out of the market altogether, or simply abandon organic agriculture.

There’s nothing terribly surprising about this. It just reminds us of why productive capacity gets aggregated into firms — including large farms — in the first place. Ronald Coase (winner of the 1991 Nobel Prize in Economics) argued as far back as 1937 that a key function of the firm is to reduce transaction costs. Included among those transaction costs are agency costs, which include most importantly the costs of monitoring people to make sure they do what they say they’re going to do.

So, what does this imply about organic coffee? The point here is that bigger farms are better at producing what consumers of organic coffee want, namely certified organic coffee. They work better not just because of the usual things we think of as “economies of scale” (access to capital to buy heavy machinery, ability to buy supplies at bulk prices, etc.) but also because it’s efficient to certify a single production system, overseen by a single management team. The idea of supporting small-time growers is of course appealing. It’s romantic. But if you’re going to stipulate that you want your coffee organic, you’re imposing a constraint, an additional monitoring cost. So don’t be surprised if costs go up or if the only producers that can supply the goods at an acceptable price are large firms. That’s what they do best!

Of course, you can also keep monitoring costs down just by turning a blind eye, which is what the USDA’s former rules permitted. The old system relied on trust — it trusted the majority of small-time growers to follow the rules in the absence of inspection. In at least some cases, that trust is likely to be violated. Is that an acceptable cost? Seems to me that’s debatable, and in the end depends upon whether consumers of organic coffee (and other organic foods) want something that’s actually organic, or just something that carries an organic label.

Links
USDA’s National Organic Program

Relevant Books:
Organic Agriculture: A Global Perspective by Paul Kristiansen, Acram Taji, and John Reganold
The Omnivore’s Dilemma: A Natural History of Four Meals, edited by Charles A. Francis et al.
Developing And Extending Sustainable Agriculture: A New Social Contract
The Firm, the Market, and the Law, by RH Coase

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