Principles, structure and application of dynamic regional sector model of Finnish agriculture

This study presents a dynamic regional sector model for Finnish agriculture (DREMFIA) to be used in evaluating the effects of different agricultural policies on production and agricultural income in Finland. Since agriculture is characterised by the long duration of investments, the economic adjustment to policy changes, like the EU integration and Agenda 2000, is likely to take a long time. Recursive programming has been used in simulating annual market reactions and economic adjustments. A process of adjustments in dis-equilibrium is assumed. The theoretical basis of the chosen modelling methodology is presented and discussed. Two versions of the model are presented. The base model assumes exogenous efficiency development, i.e. labour and capital inputs needed per hectare and animal, in agriculture. In the Finnish agriculture technical change is largely a policy variable because of the publicly financed and controlled investment aid system. Using the base model one may analyse the levels of production and income at different levels of efficiency development. The technology diffusion model used in the extended version models the change in capital invested in alternative production techniques. The change in capital is affected by the profitability of each technique, as well as the relative spread of each technique, i.e. commonly used techniques are more accessible to farmers. Hence, the new best performing techniques may only gradually replace the existing ones. In both variants, empirically validated production functions are used in determining the milk yields of dairy cows and crop yields. Feed use of animals is endogenous in the model, as is the number of animals and hectares of crops. Appropriate energy, protein, and roughage requirements of animals are included. Agricultural policy measures are modelled in detail in all 14 production regions in the model. Processing activities of 18 different dairy products have been included. Domestic and imported products are assumed imperfect substitutes (Armington assumption). It is found that Agenda 2000 results in larger grain areas and farm income in medium term, but in lower milk and beef production volumes in the long term compared to the base scenario. Also farm income will slightly decrease due to the Agenda 2000 dairy reform starting at 2005. It is also found that the long term effects of Agenda 2000 on milk production are larger if the endogenous investments are taken into account in the analysis. Index words: Agricultural sector model, policy analysis, Recursive Programming, technology diffusion, Armington assumption