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Agriculture is a risky business, not only because of its dependence on the weather. Governments, the private sector and farmers themselves need to build robust and overlapping risk-management systems that provide farmers with more than one avenue for protection.
By Sophia Murphy, Senior advisor to the Institute for Agriculture and Trade Policy
Agriculture is a risky business. At the mercy of inclement weather and pests, a frequent casualty of war, and subject to its own particular demand constraints and market failures, agriculture merits a branch of economics all to itself. The risks are not just economic: they also link to biological diversity and natural resource management, to culture and social relationships.
The risks are political, too; most farmers are subject to relatively strong government involvement in their sector – which is not surprising because everyone has a stake in agriculture. Beyond the essential fact that agriculture is fundamental to our survival, agriculture matters because it is a powerful motor for the eradication of poverty .
To realize the potential of agriculture to end poverty, however, farm prices need to be stable. Stable does not mean static: prices need to reflect supply and demand, and to a degree shortages are best managed by price. But if left entirely to the market, food prices are inherently too volatile, reflecting the uncertainties of production as well as the effects of demand elsewhere, a demand created by globalized markets that contain enormous disparities in wealth. As agricultural economist C.P. Timmer says, ‘Only political action and public response from governments can provide stable food prices.’
Two particular kinds of risk pose very modern versions of age-old challenges. The first is climate change—humankind has always been at the mercy of the weather, but today we are also directly responsible for making the weather less predictable.
"Economic forces are linking farmers from disparate parts of the world as they have never been linked before."
The second is price volatility. In an era of globalized markets, deregulated capital flows and free trade, economic forces are linking farmers from disparate parts of the world as they have never been linked before. Paul Nicholson , a farmer from the Basque region of Spain and a leader with La Via Campesina (LVC), describes the creation of LVC in the mid-1990s as a response to the similarities of the challenges that globalization presented to farmers in Minnesota and the French Midi, in Bamako and Bandung.
What risk systems to use?These risks are real, and the public has an interest in helping farmers to mitigate them. Many tools are available and risk management systems are useful in many different contexts. Governments need to build robust and overlapping systems, providing farmers with more than one avenue for protection.
One set of tools rests with farmers, though government and NGOs can play a helpful role. Collective action offers an important way for farmers to strengthen their political and economic bargaining power, and to reduce their business risks. For example, farmers can form buyers’ co-operatives to obtain fertilizer or seed or other inputs at reduced prices, or sellers’ cooperatives to negotiate better prices for a larger volume and to invest in technologies or storage facilities. Most fair trade certification depends on farmers working cooperatively.
"Public procurement and storage of grain has historically provided an important risk reduction tool."
A second set of tools rests in the state’s hands. Governments can reduce risks for farmers significantly by providing basic services, such as reliable (and affordable) transportation, affordable healthcare, and safety nets in times of crisis. Governments at all levels can also procure and hold stocks. Public procurement and storage of grain has historically provided an important risk reduction tool.
Brazil has experimented with public procurement from smallholder producers in an effort to provision safety nets for the urban poor while providing an income for the rural poor. While not easy to put into practice, the policy opens the possibility of a virtuous circle in which the risks that farmers face are reduced at the same time as consumers’ are provided with affordable food.
Holding stocks of food can help mitigate wild swings in prices by alleviating uncertainties about market supply. Credible, transparent and properly managed stocks provide a powerful tool against volatility that can work for farmers and consumers alike.
A third set of tools rest with the private sector. To give just one example, mobile phone networks have become a way to enable people without bank accounts to move money from city to country and back, while also providing farmers with price information they can use in bargaining with traders. As both a communication tool and a financial system, mobile phones have made an enormous, positive difference to many smallholder producers in the developing world.
"Mobile phones have made an enormous, positive difference to many smallholder producers in the developing world."
More prosaically, the private sector offers (at least) two big risk management systems for agriculture. One is commodity futures markets, which allow producers to sell agricultural commodities and processors to buy them before they are harvested. The parties sign a contract to deliver a certain amount of grain at a certain price on a given day. The contract itself is then bought and sold by speculators, who provide the money that the farmer needs but the processor does not want to spend until the grain is delivered.
The contract may change hands many times, with buyers and sellers trying to anticipate future prices based on projections of supply and demand. In this way, the commodity market cushions shocks.
There are costs as well, of course. Some of the attempts to create commodity exchanges in Africa (for example in Nigeria and in Ethiopia) have struggled to attract farmers because the transaction costs are great, and the minimum production to generate a contract is too big for the majority of producers.
In established markets, such as the Chicago Board of Trade (CBOT), the deregulation ushered in over the last decade or more has also undermined the effectiveness of the futures markets for price discovery. Financialization of the exchanges has increased short-term volatility, adding a new source of risk for farmers.
The second big private sector contribution to risk management is insurance. Historically, insurance companies have avoided agriculture. The risks are largely systemic (everyone in a large area faces the same growing conditions) as opposed to idiosyncratic (risks that everyone runs, but that few people are likely to suffer simultaneously, such as a house fire). This makes it difficult to manage as a private firm—you either have a great year because you sell lots of policies but get few claims, or you go bankrupt, because half your customers claim at once.
Thus even highly commercialized markets, such as the United States, have very significant gov-ernment involvement in their insurance programmes. The government subsidizes premiums, the administrative costs of the private insurers, and the final pay-outs. Indeed, the U.S. example is not an encouraging one, as both the insurers and the farmers end up with too few risks, leading to poor decisions regarding where, what and how much to plant.
New experiments with insurance in the developing world have shown more promise. These are pub-lic-private partnerships, meaning that the costs are not entirely borne by the private sector. Oxfam is involved in one scheme in Ethiopia with Swiss Re, the World Food Program and US AID (R4 Rural Resilience Initiative) that has shown success.
In Bolivia, the International Labor Organization (ILO) is working with Gates Foundation money to offer insurance to the smallest-scale producers . Insured risks include crop failure and death of a close family member. This project has shown success as well, and will be rolled out nationally in 2013.
What if?Farmers need strong risk insurance programs to have the confidence to invest in what they do. Without investment, agriculture stagnates, and so does food production. With investment agriculture can grow the food the world needs, rural economies thrive, and rural-urban migration slows.
"Farmers need risk insurance to have the confidence to invest. Without investment, agriculture stagnates, and so does food production."
Risk management systems should not encourage a farmer to take unwarranted risk. Farmers should be responsible for making good business decisions about their operations, not encouraged to take unnecessary risks as the shallow loss insurance programs proposed in the 2012 U.S. Farm Bill would. But the systems should be strong enough to protect farmers and their households from destitution, especially where the risks involved are outside farmers’ control, as is the case with climate change and international price volatility.
The public has a powerful interest in what comes of this, not only because of the primordial need to secure an adequate food supply, but also to ensure agriculture plays a vibrant role in national de-velopment, creating jobs, generating capital and husbanding natural resources for the future.
Download: Risky Business