Index-Based Yield Protection for Smallholder Farmers

78 Pages Posted: 20 Mar 2024

See all articles by Kehan Lu

Kehan Lu

Duke University - Fuqua School of Business

Jing-Sheng Jeannette Song

Duke University - Fuqua School of Business

Can Zhang

Duke University - Fuqua School of Business

Date Written: February 21, 2024

Abstract

Government subsidies are common in the agricultural sector to protect farmers from unexpected losses. Two major forms of agricultural subsidies are price protection, under which farmers are subsidized when the market price is low, and yield protection, under which farmers are subsidized when the crop yield is low. While price protection is popular in both developed and emerging economies, implementing yield protection in emerging economies is challenging due to the high costs of yield assessment for small farms. This research examines the design of a recently emerged index-based yield protection policy, which triggers subsidies when a pre-determined index (e.g., rainfall) predicts a low yield, thereby avoiding costly yield assessment. Our analysis generates several intriguing findings. First, we show that unlike subsidies that are based on actual yield, an increase in index-based subsidy may increase farmer income variance due to potentially inaccurate yield prediction of the index. Based on this result, we uncover a non-monotonic relationship between the optimal subsidy amount and the accuracy of the index. Second, although price and yield protection are often viewed as strategic substitutes since both can incentivize more planting, we show that they act as strategic complements when the index accuracy is low. Finally, when the government can exert a costly effort to improve index accuracy, contrary to expectations, we find that a tighter budget can lead to a higher optimal investment in index accuracy. Collectively, these insights contribute to a more nuanced understanding of index-based yield protection policies, aiding in developing effective agricultural subsidies.

Keywords: smallholder farmers, agricultural subsidies, yield uncertainty, index-based yield protection

Suggested Citation

Lu, Kehan and Song, Jing-Sheng Jeannette and Zhang, Can, Index-Based Yield Protection for Smallholder Farmers (February 21, 2024). Available at SSRN: https://ssrn.com/abstract=4734791 or http://dx.doi.org/10.2139/ssrn.4734791

Kehan Lu

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States

Jing-Sheng Jeannette Song

Duke University - Fuqua School of Business ( email )

100 Fuqua Drive
Duke University
Durham, NC 27708
United States

HOME PAGE: http://people.duke.edu/~jssong/

Can Zhang (Contact Author)

Duke University - Fuqua School of Business ( email )

100 Fuqua Dr
Durham, NC North Carolina 27708
United States

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