Risk and uncertainty are ubiquitous and varied within agriculture and agricultural supply chains. This stems from a range of factors, including the vagaries of weather, the unpredictable nature of biological processes.

The pronounced seasonality of production and market cycles, the geographical separation of production and end-users, and the unique and uncertain political economy of food and agricultural sectors, both domestic and international.

One major role of agriculture is the production of food. Risk and uncertainty in agriculture, therefore, have a direct effect on the achievement of the millennium goal of food security by both developed and developing countries. It is on this premise that governments at all levels must not be passive but active participants in risk management in agriculture.

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Layers of Risk in Agriculture

Roles of Government in Risk and Uncertainty Management in Agriculture

There are different layers of risks in agriculture, which require different responses:

1. Normal Risk: Variations in production, prices, and weather that do not require any specific policy response. These can be directly managed by farmers as part of normal business strategy.

2. Marketable Risk: Risks that can be handled through market tools, such as insurance and futures markets, or through cooperative arrangements among farmers. Examples include hail damage and some variations in market prices.

3. Catastrophic Risk: Infrequent but catastrophic events that affect many or all farmers over a wide area, such as severe droughts or disease outbreaks. These are usually beyond farmers’ or markets’ capacity to cope, requiring government intervention.

1. Normal Risk

Within the normal risk layer, farmers are responsible for managing their own business risks. The set of risk management strategies is decided at the farm or household level, particularly for frequent “normal” small risks in production, prices, and weather.

This is because farmers know best about their individual risk environment and how much risk they are willing to carry. Governments may need to play a role within the normal risk layer by encouraging farmers to develop their own risk management strategies.

Training programs on how to use risk management techniques, including good farming practices, the role of diversification, and the use of futures and insurance, can improve farmers’ ability to assess and manage their risks using a variety of market and on-farm tools.

Income tax and social security provisions can be adjusted to the needs of farmers. For example, paying taxes on average taxable income across a few years can help farmers cope with incomes that are quite variable from year to year. Tax incentives for saving may also encourage farmers to smooth income flows from year to year.

2. Marketable Risk

Some types or levels of risk can be dealt with using market instruments. Some large, export-oriented farmers, cooperatives, and downstream industries make direct use of futures contracts to hedge their price risks.

Many more farmers benefit indirectly from the price discovery mechanisms that these markets offer. Production and marketing contracts between farmers and the downstream industry or cooperatives are another important and increasingly sophisticated risk management tool.

There is a role for government in ensuring that the legal system properly underpins the development of these contracts, allowing enough flexibility and security of transactions. Governments can also help in training farmers and their organizations so that they are better able to use these instruments themselves.

Where there is sufficient convergence of interests, farmers can act collectively as members of cooperative societies or communal efforts to generate services necessary for risk management and implement collective risk management strategies.

3. Catastrophic Risk

Governments have an important role to play in managing catastrophic risks. These are defined as large but rare events that cause very significant damage over a wide area and to many producers, to the extent that neither individual producers nor available market instruments are able to cope.

When a disastrous event such as extreme weather or a disease outbreak occurs, the government will come under social, media, and political pressure to take action.

A set of procedures and a clear delineation of responsibilities between government and producers, defined as part of a contingency plan, are needed to manage such pressures and for the good governance of disasters. They should include explicit triggering criteria and a definition of the types and levels of assistance.

Getting the balance right between rules decided in advance and discretionary decisions made after the event is important. Otherwise, hasty recourse to ad hoc decisions will undermine the contingency plans.

The poultry industry in Nigeria experienced catastrophic risk when there was an outbreak of bird flu, which claimed thousands of birds in different parts of the country.

The government came to the rescue of affected farmers by providing relief assistance. Similarly, crop producers affected by floods in Kogi State and some other states of the federation in 2012 also received relief assistance.

The relief assistance granted to farmers experiencing catastrophic risks was not pre-planned but rather an emergency response.

In developed countries and some less-developed countries, the government explicitly delimits its responsibility in advance of any catastrophic event and tailors assistance according to the severity of the event when it occurs. This eases political pressures and simplifies the decision-making process to provide assistance in the event of catastrophes.

Rationale for Government Intervention in Agricultural Risk Management

Government intervention in markets can incur costs and create economic distortions. Thus, any interventions to manage risks in agriculture must be justified with a clear rationale, with any costs outweighed by benefits or returns to intervention.

Ideally, governments should intervene only when the market has ‘failed’ (or is expected to fail) to provide a satisfactory outcome, and this outcome can be improved by government policy. Two main reasons have been adduced for policy intervention by government:

To address inefficiencies in the operation of markets and institutions.
To address inefficiencies on equity or distributional grounds.

Inefficiencies can arise in agricultural risk markets from three sources:

i. Imperfect (or costly) information.

ii. The existence of ‘externalities.’

iii. Insufficient competition in agricultural risk markets, giving rise to market power for providers of risk management instruments (e.g., insurers).

1. Information Costs

Markets for risk management services in agriculture require information on the magnitude and probability of losses faced by farm businesses to function efficiently (Bielza Diaz-Caneja et al., 2009).

The highly unpredictable and diverse nature of risks in agriculture means this information is often unknown or very costly to acquire, both for farmers and for providers of risk management services.

The result is that the coverage of information is incomplete and unequal between participants in risk markets (e.g., farmers and insurance companies).

In agriculture, problems of incomplete or asymmetric information tend to be greater in yield risk than price risk, as farmers have more control over the former.

Asymmetric information can lead to some farmers being ‘priced out’ of markets for risk management services, as providers cannot distinguish between high- and low-risk businesses and so set premiums based on average risk, making protection (such as insurance) prohibitively expensive for farmers who are less ‘risky’ than average.

Informational problems provide scope for ‘moral hazard,’ as farmers may take fewer measures to reduce risk in the knowledge that they will receive compensation, such as an insurance payout, in the event of an adverse outcome.

Given the costs of acquiring and processing a suitable level of information are likely to be particularly prohibitive or burdensome for smaller farms, it also gives rise to distributional or equity issues.

Thus, regarding information costs, there may be a direct role for government to intervene to facilitate research to generate missing information (e.g., into weather patterns, disease prevalence to quantify risk).

Governments can also take steps to reduce the costs of sharing information between, for example, farmers and insurance companies, to overcome problems of asymmetric information.

2. Externalities

In economic terms, an externality exists when there is some cost or benefit that accrues to an outside party from a market transaction or decision that is not fully factored into market prices (and hence the decision).

A relevant example for agriculture is that of animal and plant disease. In these cases, the provision of insurance will require the insurer to obtain information to inform the level of risk that an individual business applying for insurance may suffer a loss due to plant or animal disease.

However, for any single business, the risk of a loss will depend not only on the level of investment in bio-security by that business but also on the bio-security of neighboring farms. Thus, to determine the premium, the insurer needs information beyond that of the applicant, which can be costly to obtain.

In this case, externalities in agriculture can exacerbate information problems, meaning the provision of insurance for potential losses due to animal and plant diseases is most likely to remain incomplete provided at suboptimal levels or not provided at all.

3. Market Power

Where a market is characterized by very few suppliers, as is the case in many markets for agricultural insurance, the suppliers will tend to have some power to influence market prices and ultimately the ability to generate economic rent or “abnormal profits.”

This is an indicator of a lack of competition in agricultural insurance markets. The result is that even subsidies on insurance premiums do not always benefit farmers, as suppliers of agricultural insurance are able to capture such subsidies as economic rent.

In such cases, governments may have a role in improving market competition by, for example, removing barriers to entry to increase competition in the insurance market.

4. Distributional Concerns

In addition to economic efficiency grounds, government intervention may be justified by concerns over the distribution of market outcomes.

It is possible to argue that agricultural enterprises are less able to manage risk privately than operators in other industries due to the relatively small size of many farm businesses and the relatively low profit margins on which they operate (Matthews, 2010).

Risk exposure in agriculture may be high relative to other industries due to the greater uncertainty on the wide range of factors on which agricultural businesses depend.

As discussed earlier, agricultural output prices are particularly volatile due to the unresponsive nature of demand for food products to price changes and the presence of other risk sources, such as weather and disease.

The ability to cope with and manage risk also differs within agriculture and between agricultural businesses due to the type of enterprises, size of business, and other factors. Thus, there may be justification for intervention by government on the basis that farm businesses and households are more vulnerable to some risks than those that draw their income from other sectors.

Risk Management-Related Policies in Agriculture

Organisation for Economic Co-operation and Development (OECD) studies show that risks in agriculture are interconnected, sometimes compounding, sometimes offsetting each other.

For example, if the prices of inputs (e.g., fertilizer) and outputs (e.g., agricultural commodities) move in the same direction, the impact on net returns is reduced. Production risks can be partially offset by price movements, as when crop yields are low but prices are high.

It is the net risk effect on income that matters, and income variability can be significantly reduced thanks to these interconnections. While all agricultural policies affect the risk environment faced by farmers and their responses to risk, certain policies can be seen as more targeted at reducing or mitigating risk or helping farmers cope with adverse outcomes. The main driver for agricultural policy and among its objectives is the stabilization of agricultural markets.

Price Stabilization Policies

There is a range of policy instruments that have traditionally been used at country or regional levels to reduce the exposure of the agricultural industry to market or price risks. Broadly, these policies are targeted at addressing problems associated with output price volatility. A broad list of these policies is provided below.

i. Export Subsidy

Export subsidy is a government policy to encourage the export of goods and discourage the sale of goods on the domestic market through low-cost loans or tax relief for exporters, or government-financed international advertising or research and development.

Export subsidies are also generated when internal price supports, such as a guaranteed minimum price for a commodity, create more production than can be consumed internally in the country. Export subsidies are payments made by the government to encourage the export of specified products.

ii. Import Tariffs

An import tariff is a tax placed by governments on commodities that are shipped into a country from a foreign country. These taxes are often a way to discourage a country’s consumers from buying products from another country and to support domestic products and services.

Governments generally have the right to determine what products will have a tariff and how much that tax will be. Governments often use two types: ad valorem and specific.

A specific tariff is a set tax on a product, and this tax is the same on all products of its kind. An ad valorem tariff, on the other hand, is a tax based on a percentage of the value of the product. This tariff can change from time to time as the value of the product increases or decreases.

Governments can also impose a two-part tariff, which includes a specific and an ad valorem tariff. A product with a two-part tariff would have a set tax as well as a value-based percentage tax.

An import tariff that is sufficiently high can protect producers from variability in world prices by limiting imports. However, this can be at the expense of higher prices and reduced choice for consumers.

If the government imposes a high tariff on agricultural products like rice, maize, wheat, etc., it will help mitigate price risk because it will make imported agricultural products more expensive than domestic products, thereby compelling citizens of that country to consume locally produced agricultural products.

iii. Guaranteed Agricultural Prices

This involves the enactment of legislation giving the farmer more or less precise guarantees of the price level or the minimum price they may expect some time ahead. These prices generally lie within certain fixed percentages of the parity prices.

Several years ago, Nigeria had a system of guaranteed prices under which minimum support prices were announced by the government for major food grains and cocoa well in advance of the sowing season, with the clear objective of mitigating price uncertainty.

One of the major uncertainties that afflict farming activity emerges from the frequent phenomenon of sudden and precipitous falls in the prices of agricultural commodities. The objective of guaranteed minimum prices, as universally understood, is to remove this uncertainty.

iv. Buffer Stock (Intervention Purchasing & Public Storage)

Buffer stock operations aim to remove price uncertainty. In this method, the buffer stock authority, or government agency, purchases stocks of agricultural commodities in years of bumper harvest and unloads them into the market in years of crop shortages, with a view to raising prices in times of glut and lowering them in times of scarcity.

Thus, by neutralizing year-to-year fluctuations in output, buffer stock operations can bring about greater regularity in the year-to-year availability of crops and, at the same time, promote rational economic decisions on the part of farmers by reducing price uncertainty.

In Nigeria, the buffer stock scheme is mainly for grain crops especially maize for which the government built silos in several locations in the country.

An essential condition for the smooth and efficient functioning of the buffer stock scheme is that the buffer stock authority must be able to maintain a balance between its purchases and sales over a period.

Continuous purchase by the buffer stock operating agency of a commodity due to its glut in the market for a very long period will put a great strain on the resources of the concerned agency. Its continuous sale for a very long period will lead to the complete exhaustion of its stock lying with the agency.

Both ways, the operations of the buffer stock scheme will suffer. This implies that buffer stock schemes will be more successful if the price changes needed to be controlled are not unidirectional only.

The buffer stock operating agency must fix judiciously the ceiling and floor prices it wants to maintain. If the ceiling price is fixed at quite a high level and the floor price at a rather low level, then the scheme would be very easy to implement, but it may not achieve any meaningful stabilization because a high ceiling price and a low floor price of the concerned commodity can fluctuate without any interference.

If the ceiling price is relatively low and the floor price high, the degree of price stabilization achieved would be high, but this may jeopardize the scheme itself because the buffer stock authority would be required to purchase stocks even in cases of wild glut and to sell stocks even when there is only a little fall in production.

In this article, the need for government intervention in risk management and the instruments that governments use to mitigate or assist farmers in coping with agricultural risks have been discussed.

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