African Agricultural Decisions after Relaxing Credit and Risk Constraints
When provided with insurance against the primary catastrophic risk they face -- drought or floods -- farmers are able to find the resources to increase expenditure on their farms.
In recent decades lagging agricultural productivity in sub-Saharan Africa has motivated charities and policymakers to implement assistance programs, usually by promoting hybrid seeds and fertilizers. But in focus group interviews, farmers in the region commonly report "lack of money" or concerns regarding the high risk from weather and disease as key obstacles to investing in their land.
In Agricultural Decisions after Relaxing Credit and Risk Constraints (NBER Working Paper No. 18463), co-authors Dean Karlan, Robert Osei, Isaac Osei-Akoto, and Christopher Udry analyze the results of experiments conducted in northern Ghana in which farmers randomly received cash grants, opportunities to purchase rainfall index insurance, or a combination of the two. They find that when provided with insurance against the primary catastrophic risks they face, the farmers are able to find the resources to increase expenditures on their farms.
The authors seek to understand how capital and risk interact, and under what circumstances they lead to underinvestment. To do this, they devise a three-year random experiment. In year one, maize farmers are provided a cash grant (or no cash grant) and a rainfall insurance grant (or no rainfall insurance grant). In year two, a cash grant is again offered, but rainfall insurance is no longer given out for free. Instead, it is for sale at randomly varied prices ranging from one eighth of its actuarially fair price to the market price (that is, actuarially fair plus a market premium to cover servicing costs). In year three, the farmers are offered only the insurance pricing experiment.
The researchers find that agricultural investment responds quite a bit to the rainfall insurance grant, but relatively little to the cash grants. The salient constraint to farmers' investment appears to be uninsured risk: when provided with insurance against the primary catastrophic risk they face -- drought or floods -- farmers are able to find the resources to increase expenditure on their farms. Even at the actuarially fair price for insurance, 40 to 50 percent of the farmers demand it, and they purchase coverage for more than 60 percent of their cultivated acreage. Because the farmers do not seem to completely trust that payouts will be made when rainfall insurance trigger events occur, the demand for insurance is sensitive to the experience of the farmer himself and to that of others in his social network with insurance. Demand for insurance increases after either the farmer or others in his network receive an insurance payout, and demand decreases if a farmer was previously insured and the rainfall was good, resulting in no payout.
The authors suggest that their experiment provides an important lesson for the microcredit community: capital constraints are not the only, or sometimes even the most important, hurdle to raising investment. Risk is a key hindrance to investment and thus to improved income and growth. Mitigating risk even without an infusion of capital leads to higher investment.