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Abstract:
Agricultural innovation can help farmers improve their productivity, reduce their environmental impact, and address the challenges associated with ever-changing soil, weather, and market conditions. Promoting innovation often requires government support as a way to incentivize producers to experiment with (and then eventually adopt) cutting-edge practices. We investigate the effectiveness of a number of policy instruments, i.e., taxes and subsidies, in terms of their impact on the adoption of innovative production methods, producers’ profits, consumer surplus, and return on government expenditure. We contribute to the existing literature by investigating not only the policy maker’s role in encouraging innovation but also the role of consumer preferences and learning-by-doing benefits of new production methods. Our setting features producers with access to traditional and innovative production methods and consumers that have a higher valuation for the output of the innovative method. We develop a model to analyze producers’ decisions of whether to experiment with a new production method when facing uncertainty about their production yield as well as the benefits associated with learning-by-doing. Our findings indicate that using only taxes encourages experimentation with new production methods but decreases social welfare. Utilizing only subsidies outperforms policies that involve both taxes and subsidies in achieving higher social welfare but the converse is true in achieving a higher experimentation rate. We show that zero-expenditure policies result in a decline in social welfare unless producers face financial barriers when making the costly transition to new methods. The insights we generate can help policy makers design policies to achieve specific objectives, e.g., target experimentation/adoption rates. We illustrate their applicability by conducting a numerical study using data on conventional and organic egg production in Denmark. The study generates concrete policy recommendations to achieve the organic production goal set by the Danish government.