Index-Based Yield Protection for Smallholder Farmers
78 Pages Posted: 20 Mar 2024
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
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