Assessing the production and welfare effects of agri-environmental policy: a conceptual analysis

The paper develops a conceptual framework for the welfare analysis of agri-environmental policy targeting the use of agricultural inputs within an international trade context. Based on a two-factor production model, we analyze the marginal social costs of agricultural production with and without an efficient agri-environmental policy. We demonstrate that an assessment of social external costs based on factor intensities in the absence of environmental policy underestimates the potential welfare improvements that can be achieved by introducing an efficient agri-environmental policy. We demonstrate further that, even if the marginal environmental effect of farming is negative in the absence of agri-environmental policy, the existence of positive externalities may cause production levels to rise as a result of an optimal environmental policy.