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Risk, Government Programs, and the Environment
Michael J. Roberts, Craig Osteen, and Meredith Soule
Technical Bulletin No. (TB-1908), March 2004
Prices and yields of most agricultural commodities vary markedly
in unpredictable ways. How do these risks and the government
programs designed to mitigate them influence the crops farmers
choose to produce, the amounts they produce, and their production
practices? How do farmers’ production decisions, in turn,
influence environmental quality?
This report provides researchers and policy analysts with an
overview of the different ways risk can influence production
decisions in agriculture. It describes research that examines
the links between risk and the production decisions farmers
make, and how different agricultural production practices in
turn influence risk, farming profits, and environmental quality.
The report also discusses ways to overcome some of the key challenges
involved with research in this area.
What is the Issue?
Concern about the amount of risk and farmers’ ability
to efficiently cope with it has served as an important backdrop
for government agricultural support programs. These programs,
a central feature of U.S. agriculture since the Great Depression,
have mainly taken the form of price supports and supply control
programs. In the last decade, government programs that directly
target risk have been expanded to include counter-cyclical payments
and increased subsidies on yield and revenue insurance. In addition,
Congress periodically approves ad hoc disaster assistance to
compensate farmers for extreme local weather events that damage
or destroy crops. All of these programs transfer wealth to certain
farmers from the rest of the economy and reduce risks associated
with some farm operations.
These policies have revived interest in classic economic questions
about how well private markets function to provide risk-coping
tools to farmers in the absence of government policies and to
what extent government programs actually alleviate the costs
of coping with risk. Risk and government programs that manage
risk can influence the crops farmers plant, their production
practices, and even the organizational structure of entire agricultural
sectors. These decisions, in turn, may have environmental consequences.
How Was the Study Conducted?
The report first describes how individual incentives are shaped
by risk and explains how markets can trade and thereby share
risks. It then reviews two general ways that risk can influence
choices in an idealized world of perfect markets. The report
goes on to explain why markets are not perfect and reviews three
additional ways for modeling the effects of risk in imperfect
markets. Each modeling approach is presented using a basic example—the
goal is not to spell out every implication of each approach,
but to illustrate the economic trade-offs underlying each one,
so the reader can gain perspective on many possible consequences
of risk.
The report provides a brief overview of the relevant agricultural
programs, characterizes the different kinds of production alternatives
available to farmers, and explains how these alternatives may
influence risk, returns, and the environment. The report discusses
the difficulties of empirically measuring the impacts of risk
and provides six conclusions.
What are the Major Findings?
Risk is difficult to measure and the effects of risk are easily
confounded by the effects of factors that have nothing to do
with risk. Future work would benefit from a more careful account
of these factors.
Risk can affect farm production decisions and the environment
through many different channels besides farmers’ attitudes
toward risk (or ‘risk aversion’). For example, the
uncertainty of rainfall and the cost of assessing soil conditions
may alter a farmer’s application of nutrients even if
he is risk neutral. Or, uncertain future income may alter a
farmer’s investment plans because of an inability to obtain
credit in the event income is low. Alternatively, because investment
decisions are often reversible or partially-irreversible, uncertainty
about future prices can affect a farmer’s investment plans
in an entirely different way.
In some cases, the effects of risk on production can appear
similar regardless of the channel through which they arise.
Because policy implications may be different depending on which
channel gives rise to the effects observed, future research
would benefit from improved understanding of the relative importance
of the different channels.
Future research on the effects of risk would benefit from an
improved understanding of how key environmental factors, such
as location, climate and soil, affect land use. These factors
are among those most likely to confound the effects of risk
in empirical studies. These links are also central to understanding
the effects of agricultural production on environmental quality.
Many economic models linking production to risk are static
in nature. These models overlook important long-run risks, which
are more difficult for farmers to insure than short-run risks.
Long-run risks are central to key production decisions, including
capital investment, technology adoption, crop rotations, and
tree plantings.
Some research supports psychological models of behavior at
odds with standard assumptions in economic models, especially
certain models pertaining to risk. Future research would benefit
from empirical study into the practical relevance of these psychological
models for farmers’ production decisions.
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