Agricultural Risk Management or Income Enhancement?

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Crop insurance reform is again on the agenda of agricultural policymakers. Some in Congress want to add at least $1 billion in subsidies to a program that is currently budgeted at $1.7 billion annually. Others want to introduce subsidized livestock insurance for the first time. Even President Clinton called for crop insurance reform in his 1999 State of the Union Address. Everyone is talking about shoring up the safety net with more subsidized insurance.

Before Congress moves forward with more subsidies under the rubricof riskmanagement, it is important to take stock of existing programs andsubsidies. When farmers must pay for risk protection at least what theyexpect to get back over the long term, the risks become internalized intotheir decisions. When farmers pay less than they will get back inindemnities resulting from insurance subsidies, society pays them to takeon additional risk. The resources used in taking on those risks cost theeconomy much more than just the income transfer imbedded in the subsidy.There is the additional cost of inefficiency created by the subsidy.

As potential owners of farmland recognize the value of thesubsidies, theywill bid more for farmland, bidding up land prices and creating barriers toentry by new farmers. Under such conditions one must ask who is beinghelped. About half America's farmland is farmed by a nonowner. Ifagricultural subsidies were more properly characterized as transfers fromtaxpayers to landowners (many of whom are not farmers), raising land pricesand making entry into farming more difficult for the small farmer,political support might diminish.

Farmers whose risks are subsidized will push harder and faster andtake onmore risk. They will borrow at higher rates. The likely result is thesame failure rate as before subsidies existed. For example, when farmershave access to subsidized crop insurance, their bankers will lend them moremoney. Lending more reduces farmers' access to credit when there aretemporary shocks. Subsidized crop insurance reduces farmers' incentives tomanage risk.

Farmers paid $930 million in premiums in 1998, or about 35 percentof theexpected total cost of the program. When free disaster aid is added totaxpayer contributions, farmers paid about 20 percent of the cost. For1999, premiums will be reduced another 30 percent (an additional $400million in subsidies). With the same participation rate as in 1998, thetotal cost of the crop insurance program will exceed $2.5 billion in 1999.Farmers will pay about $650 million, 25 cents on the dollar.

Despite the small share of the costs that are borne by farmers,membersof Congress and others are calling for still more subsidies, arguing thatwith higher subsidies, more farmers will 'buy' crop insurance, reducing thelikelihood that free disaster aid will be needed. However, the more thandoubling of subsidies that came with the 1994 reform did not preventdisaster aid in 1998. Are we destined simply to make our insurance programsinto something like a multi-billion-dollar standing disaster assistanceprogram for which farmers pay ever fewer pennies on the dollar?Although there are several unintended consequences that are common withagriculture subsidies, there are more serious unintended consequences whensubsidies are tied to farm-level yield risk. Subsidies that are a directfunction of premiums will transfer relatively more money to high-riskfarmers and high-risk regions. Furthermore, the subsidies have caused moretotal acreage and lower prices. The price declines hurt the most productiveregions and the risk transfers help the most risky regions. Is that thereward structure we want for U.S. agriculture? Everyone thinks we can fixthe problems in agriculture with risk-management instruments like crop andrevenue insurance. But to the extent that agricultural insurance marketsare built with heavy subsidies, we will be no better off, and possiblyworse off, than we were before the reform in the 1996 Farm Bill.

Like other subsidies, insurance subsidies will have limited success indoing what they are supposed to do - save the family farm. Thebeneficiaries are, agricultural lenders, insurance companies and those whosell the insurance, and landowners, who are in many cases not familyfarmers. Recognizing that farmers respond to subsidized insurance by takingon more risk and returning to pre-subsidy levels of risk is important. Tryas they might, Congress cannot take the risk out of U.S. agriculture.

Jerry R. Skees

Jerry R. Skees is professor of agricultural economics at the University of Kentucky. This article is excerpted from Regulation, Vol. 22, No. 1, published by the Cato Institute.