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Agricultural policies and risk management in OECD countries - presentation at the International Conference in Madrid (November 2006)

Author: Jesus Anton, OECD Directorate for Food, Agriculture and Fisheries, Paris
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Lins to source: www.mapa.es

The document is adopted and prepared for publication by Roman Shynkarenko, Project Manager, www.agroinsurance.com

Objectives of presentations:

–          Defining the context in which any policy intervention, particularly on Agricultural Insurance, takes place: all agricultural policy interventions and international constraints (WTO);

–          Underlying the need of coherence among policies and market strategies.

Main sources:

–          OECD (2206): “OECD Agricultural Policies 2006: at a glance;

–          OECD (2005): “OECD Papers: Special Issue on Decoupling Agricultural Support”;

–          OECD (203): “ Analysis of the 2002 Farm Act in the United States:;

–          OECD (200): “Income Risk Management in Agriculture”;

–          WTO: Member countries’ notifications.

Risks in agriculture include production, market, financial, environmental, institutional, regulatory, health, property, policy, etc.. Each type of risk has its own characteristics: frequency and distribution of occurrences, magnitude of losses, randomness, correlation, etc.

Risk management strategies used in different countries:

–          Managing finance/diversification of income sources;

–          Production techniques;

–          Market techniques: spreading sales, storage, contracting, etc.;

–          Vertical co-ordination – response to cosumers’ segmented demands and risk reduction… but it lowers prices, market power and unavailability;

–          Futures markets – varying and growing use plus innovative contracts… but demand under support, unavailability, need of training, cost;

–          Insurance systems – few entirely private, varying levels of intervention, no need of ad hoc measures and foreseeable budgetary cost… but transaction costs and it may create support, moral hazard, rent seeking;

–          Safety nets – through social security, taxation systems, agricultural programs (Canada).

Any government considering to take policy actions should understand the following issues that should be addressed while developing agricultural insurance (risk management) system. Initially the experts should decided how to solve the basic problem issues with agricultural insurance:

o   Information failure – adverse selection and moral hazard;

o   Systemic vs idiosyncratic risk;

o   High transaction costs

Assessment of the efficiency in risk management in agriculture and in the economy should include answers to the following questions:

–          Is risk in agriculture higher than in other sectors?

–          Is contingency market failure deeper than in other sectors?

–          Is  government intervention cost effective?

Instruments for social policy include provision of help to poor farmers to adjust after shocks, but the  criterion should be “poor” not  “farmer” and refer to whole farm household income.

There are several points of view on these questions. Most governments currently decide to start developing agricultural insurance systems with the involvement of the state support. However some countries consider it might be more cost-efficient to provide assistance  only when catastrophic weather events happen. The other risks should be managed by the farmers themselves through various strategies including private insurance (see presentation on German system of agricultural insurance presented at Madrid conference – www.agroinsurance.com)

The context of domestic support to agriculture in OECD countries

The governments can intervene on farmers income risk through various instruments including:

–          Economic environment – stable macro parameters (exchange rates, inflation) and well-functioning markets for inputs and outputs (eg. Credits);

–          Regulations – food safety, environment, land and labour;

–          Social and fiscal policies – income safety nets, income smoothing tax systems;

–          Agricultural policies – level and composition of support in OECD countries (total and producer support estimate, TSE/PSE), types of instruments and mechanisms through which they affect risk.

Support to producers (PSE) in OECD countries includes:

–          Market price support (MPS): Qs*(Ps-Pw)

–          Budgetary payments (BPP) based on implementation criteria:

o   Payments based on output;

o   Payments based on area planted/animal numbers;

o   Payments based on historical entitlements;

o   Payments based on input use;

o   Payments based on input constraints;

o   Payments based on overall farming income.

The governments subsidize provision of social services to rural sector (GSSE) through supporting schools, inspection, infrastructure, marketing/promotion, public stockholding. The total support to agricultural sector is estimated as TSE = PSE + GSSE + Consumer subsidies.

The average PSE % in OECD countries is approximately 30% though it varies from 2% in New Zealand, 5% in Australia to 62% in Korea and 69% in Zwitzerland (2003 OECD data). (Mexico – 15%, USA – 16%, Canada – 22%, Turkey – 26%, EU – 34%, Japan – 58%).

Main subsidized insurance and safety net programs in OECD include (PSE category):

–          Disaster payments – most countries;

–          Crop insurance – Canada, the USA, Mexico, Spain;

–          Revenue insurance – Canada (some provinces) and the USA;

–          Payments based on revenue losses – Canada (CFIP) and the USA (market loss assistance /  counter-cyclical payments);

–          Safety nets:

o   system based on savings (NISA in Canada);

o   welfare, transitional assistance (Australia, Ireland, Korea);

o   income smoothing taxation systems (Australia, Sweden).

How agricultural support affects risks and production?

All policy instruments affect risk, including through policy risk. This includes:

–          “Decoupled” income support (wealth effect);

–          Regulations, input subsidies and general services affect yield variability and receipts;

–          Coupled support affects farm receipts and sometimes input use.

Some measures in all categories have stabilizing mechanisms – intervention prices, deficiency payments, stabilization payments based on area, crop and revenue insurance, historical entitlements or overall income.

Most categories of support reduce revenue variability, some to large extent. MPS always affect receipts (size and mechanisms). Variability reduction is not proportional to support size. Some measures that are meant to compensate for income losses increase variability upwards.

Interaction between policy measures

In general, risk reducing payments crowd-out the use of market strategies, particularly if they cover against the same source of risk. There can be perverse effects – risk reducing support might end up increasing farmers’ income variability. There is a strong need to coordinate all risk reducing measures to preserve balance of market-based measures and potentially distorting policy interventions.

Results on Production impacts

Price effect dominates for most categories but risk-related effect can be large and wealth effect small in most cases. For specific policy changes with counter-cyclical design like 2002 US Act, risk (insurance) effects can be the main effect. Insurance subsidies in Spain result in small but statistically significant impacts on production (increase).

The International context: WTO boxes and notifications

There are three pillars in URAA: market access, domestic support and export suibsidies.

Amber box – measures that distort trade. De minimis – commodity and non commodity specific support under 5% of the total value of production. Blue box – direct payments under production limiting programs. Green box – measures that do not, or only to a minimum extent distort trade and minimum effect on production. The green box measures can include publicly funded support with no transfer from consumers and support that does not provide price support to producers.

Decoupled income support:

–          Eligibility based in clear criteria such as factor use or production level in a defined and fixed based period;

–          The amount of payments will never be based on information on any year after the based period about: type or volume of production, prices or factor use;

–          No production shall be required in order to receive the payment.

Government participation in income insurance and income safety net programs:

–          Eligibility determined by a gross agricultural income loss exceeding 30% of recent past average;

–          The amount of the payment will compensate for less than 70% of the loss;

–          The amount of payments relates solely to income and not to production or prices;

–          These payments plus relief from natural disasters cannot exceed producers’ losses.

Payments for relief from the natural disaster (including participation in crop insurance schemes):

–          Eligibility after a government formal recognition of a natural disaster, determined by a production loss exceeding 30% of recent past average;

–          Payments applied only in respect to the losses and with a maximum compensation equal to the cost of replacing;

–          These payments plus income insurance cannot exceed producer losses.

Insurance subsidies and counter-cyclical payments in OECD countries:

                                                  EU (2001/02)    US (2001)       Canada (2001)      Japan (2000)

Green income insurance                     2%                  0%                  22%                0%

Disaster relief (green box)                 58%                 18%                 0%                  73%

Insurance in de minimis                     40%                23%                41%                27%

Other in de minimis                           0%                  59%                37%                0%

Other countries’ insurance and counter-cyclical payments (last notification) (2001)

                                                         Chile          Morocco              Tunisia                 Turkey

Green income insurance                     57%                0%                  0%                  0%

Disaster relief (green box)                 43%                 100%               0%                  0%

Insurance in de minimis                     0%                  0%                  0%                  0%

Other in de minimis                           0%                  0%                  0%                  0%

Income insurance and safety nets

OECD countries:

–          Australia: Farm management deposit scheme (no payment made)

–          Canada: Alberta Farm Income Disaster Program and Prince Edward Island Agricultural Disaster program

Non-OECD countries:

–          Argentina: support to compulsory hail, work accident and life insurance (special tobacco fund) + creation of solidarity fund for hail insurance coverage 9since 1997);

–          Costa-Rica: insurance services including crop insurance;

–          India: Crop Insurance Scheme, farm management deposit scheme (no payment made);

–          Sri-Lank: income insurance, income safety net program.

Relief from natural disasters and crop insurance

OECD countries:

–          Australia: Rural Adjustment Scheme; tropical fruit producer assistance (1996); exceptional circumstances relief payment; contribution to regional disaster fund, interest subsidies (state funding), etc.;

–          EU: compensatory payments in respect of weather, restoration of agricultural potential and natural disasters (re-plantation of olive grove in 1996);

–          Hungary: migration of damage caused by drought;

–          Japan: government subsidy on agricultural insurance premiums, natural disaster relief loans;

–          Korea: compensatory payments for losses caused by natural disasters;

–          New Zealand: administrative cost of providing advisory services to farmers affected by drought and paying army personnel for the distribution of water to farms households;

–          Norway: compensation for crop damage due to natural disaster;

–          Poland: protection against and relief from flood and restoration of agricultural production;

–          Slovak Republic: partial damage reimbursement;

–          Slovenia: compensation for production losses caused by disaster;

–          US: non-insured crop disaster assistance program (NAP); compensation for feed or forage losses; loss of tree seedlings; livestock losses; emergency loands.

Non-OECD countries:

–          Argentina: personal loads for development and refinancing loans;

–          Botswana: disaster/emergency aid;

–          Brazil: agricultural insurance program;

–          Chile: agricultural insurance and agricultural emergency fund;

–          Colombia: disaster relief;

–          Cuba: state agricultural insurance program;

–          Cyprus: contribution to agricultural insurance organization;

–          India: scarcity relief and natural calamities program;

–          Indonesia: payments to help when natural calamities occur;

–          Israel: contribution to a national disaster insurance program, advance payments and payments for farmers not covered by insurance, administration cost subsidy;

–          Morocco: aid to deprived regions or regions hit by disaster;

–          Namibia: drought aid;

–          Philippines: crop insurance and calamity fund;

–          South Africa: subsidies for disaster aid.

Risk reducing in De Minimis – WTO notifications:

–          EU (2002) – insurance subsidies;

–          United States – crop and revenue insurance subsidized by the Federal Crop Insurance Corporation; multi-year crop disaster payment; crop market loss assistance payments;

–          Canada – net income stabilization account (NISA); crop insurance;

–          Japan (2000) – agricultural insurance scheme.

Conclusions

Current negotiations – crop insurance may not require formal recognition by government authorities of a natural disaster. Strategies to reduce income risk depend on the characteristics or risk and require a set of tools and instruments. The role for the government in risk management is to provide a sound business environment with competitive markets and clear regulations, to facilitate the development of market mechanisms and, when market fails, to provide instruments (in general fro high levels of risks) according to reform principles.

Interventions should be effective and cost-efficient, minimally distorting, delivered in a transparent, decoupled and targeted way. Interventions should avoid undermining the development of private/market solutions, or hindering the adjustment capacity of the sector and not encouraging rent-seeking. The instruments should limit the impact of moral hazard and adverse selection factors.

This seems not to be the case in most OECD countries:

–          Policies have contradictory objectives;

–          Most support is linked to production;

–          Mixed experience from insurance and safety-nets in North America (Canada safety nets versus US moves to more traditional subsidies);

–          Ad hoc intervention gives farmers contradictory incentives.

There is a need for more information on the mechanisms available, their utilization, performance and their economic impact assessment. The governments and other market parties should consider importance of training and information activities. There is a need in sharing experience internationally and assuring strong integration between private and public initiatives.