Do Agricultural Policies Crowd-out Risk management
Strategies? Evidence from Farm level analysis

Jesús Antón, Shingo Kimura

Trade and Agricultural Directorate, Organization for Economic Cooperation and Development

Abstract:
This paper assesses farmer’s exposures to risks at the farm level from seven countries and develops a model representing the decisions of an individual risk averse farmer facing variability in both prices and yields. A set of stylized risk market instruments is represented. The model is calibrated using farm level data from the UK and Germany and Australia. Monte-Carlo simulations of the random variables are run, and the corresponding optimal responses are obtained. The main focus of this paper is the interactions between government payments and the farmers’ use of risk market instruments in terms of the potential crowding out of such instruments and impacts on farm return and welfare.

Unlike other studies this paper models farming response to payments in terms of production and the use of risk market instruments that are endogenous. Current policies such as cereal price intervention and single farm payment mitigates farmer’s efforts to reduce farming risk by the potential crowding out of substitutive strategies. The simulation analysis indicates a number of potential interactions between government programmes and risk management strategies. The first example is the policy impact on producer’s crop diversification strategy. It is shown that even the most decoupled payment could affect the producer’s decision on crop diversification; government efforts to stabilize income through subsidizing yield insurance premium or forward price could partly be offset by the farmer’s crop diversification strategy to pursue higher return with higher variability. The crowding-out effect of the crop diversification strategy is an important factor to determine the effectiveness of the government programmes to reduce the income variability. The second example is the policy impact on the use of risk market strategy. In some cases, the use of risk market instruments is partially crowded out by the government payments. If some risks are covered by the government programmes, the incentive to use market strategy to manage such risks is reduced.

Keywords: Risk, Welfare, Expected Utility, Crop yield insurance, Forward contracting and Crowding out