RISK MANAGEMENT AND THE ENVIRONMENT: AGRICULTURE IN PERSPECTIVE

RISK MANAGEMENT AND THE ENVIRONMENT: AGRICULTURE IN PERSPECTIVE

Risk Management and the Environment: Agriculture in Perspective Edited by Bruce A. Babcock Center for Agricultural and Rural Development (CARD), Iowa State University, U.S.A. Robert W. Fraser Imperial College, Wye, u.k. and Joseph N. Lekakis Department of Economics, University of Crete, Greece " ~. SPRINGER-SCIENCE+BUSINESS MEDIA, B.V.

A C.I.P. Catalogue record for this book is available from the Library of Congress. ISBN 978-90-481-6158-4 DOI 10.1007/978-94-017-2915-4 ISBN 978-94-017-2915-4 (ebook) Printed an acid-free paper AII Rights Reserved 2003 Springer Science+Business Media Oordrecht Originally published by Kluwer Academic Publishers in 2003 Softcover reprint of the hardcover 1 st edition 2003 No part of this work may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, microfilming, recording or otherwise, without written permission from the Publisher, with the exception of any material supplied specifically for the purpose of being entered and executed on a computer system, for exclusive use by the purchaser of the work.

Contents Tables Figures Contributors Preface vii ix x xii Introduction Risk Management and the Environment 1 in Agriculture: A Key Policy Theme Bruce A. Babcock, Robert W. Fraser, Joseph N. Lekakis Part I Theory Chapter The State-contingent Approach to Modeling Environmental Risk Management John Quiggin and Robert G. Chambers 11 2 The Precautionary Principle in Practice: How to Write a Call Option on the Environment Greg Hertzler 29 3 Factors Determining Best Management Practice Adoption Incentives and the Impact of Green Insurance Paul D. Mitchell and David A. Hennessy 52 4 Uncertainty and Adoption of Sustainable Farming Systems ~~J~M~ ~ 5 Incentive Design for Introducing Genetically Modified Crops Ross Kingwell 82

~ ConUn~ 6 An Economic Risk Assessment of the Impact on Producers of Removing Quarantine Restrictions Robert W. Fraser 96 Part II Case Studies 7 Risk Attitudes and Risk Perceptions of Crop Producers in Western Australia Amir K. Abadi Ghadim and David J. Pannell 8 Valuing Pest Control: How Much is Due to Risk Aversion? Terrance M. Hurley and Bruce A. Babcock 9 The Influence of Price Risk on Set-aside Choice in the EU Hild Rygnestad and Robert W. Fraser 10 Production Risks, Acreage Decisions, and Implications for Revenue Insurance Programs JunJie J. Wu and Richard M. Adams 11 The Effects of Crop Insurance and Disaster Relief Programs on Soil Erosion: The Case of Soybeans and Corn Barry K. Goodwin and Vincent H. Smith 113 134 145 161 181 Conclusion Bruce A. Babcock, Robert W. Fraser, Joseph N. Lekakis 196 Author Index 199 Subject Index 203

Tables Table 1. 1: Problem Taxonomy 20 2. 1: Parameter Values 37 3. 1: Sequence of Events for Each Production System 58 5. 1: Parameter Values for the Numerical Analysis 89 5.2: Base Case Findings 90 5.3: Sensitivity Analysis of Problem of Illegal Production of GM Crops 91 6. 1: Base Case Results of the Perception of the Impact of Introducing Imports on Income Risk 103 6.2: Perception of the Impact of Introducing Imports on Income Risk: More Elastic Demand 104 6.3: Perception of the Impact of Introducing Imports On Income Risk: Greater Seasonal Variability 105 6.4: Perception of the Impact of Introducing Imports on Income Risk: Disease Reduces Expected Yield 106 6.5: Perception of the Impact of Introducing Imports On Income Risk: Greater World Price Variability 107 6.6: Perception of the Impact of Introducing Imports On Income Risk: Higher Average World Price 107 7. 1: A Sample of an Elicited and a Contract Price Scheme Distribution Used in Estimating the Risk Aversion Coefficient of the Individuals in the Sample 122 7.2: Perceived Mean Yields for Chickpeas and Wheat 124 7.3: The Coefficient of Variation of Chickpea and Wheat Yields Calculated from Individual Subjective Probability Distributions. 126

viii Tables 7.4: The Range of Covariance Values Observed among Farmers in the 1997 Sample 128 7.5: Proportion of Farmers with Different Levels of Risk Aversion in the 1997 Sample 129 8. 1: Per-Acre Willingness to Pay for 8t Corn 141 9. 1: Prices and Risk, 1998/99 152 9.2: Parameter Values for Three Yield Response Functions, Denmark 153 9.3: Cost-structure and Other Parameter Values for Three Land Qualities, no Price Risk, Denmark 153 1998/99 9.4: Standard Leaching Rates for Three Land Qualities, Denmark 154 9.5: Prices and Risk after Implementation of the Agenda 2000 Reform 154 9.6: Relative Expected Utility (Net Present Value) with Price Risk, Heterogeneous Land Quality and Different Levels of Risk Aversion 157 10. 1: Estimated Coefficients for the Logistic Regression Model of Corn and Soybean Acreage Responses 171 10.2: Estimates of Acreage Elasticities 173 10.3: Changes in Crop Mix under Revenue Insurance 174 11. 1. Variable Definitions and Summary Statistics 186 11. 2: Parameter Estimates and Summary Statistics for Models of Insurance Purchases 189 11. 3. Three-Stage Least Squares Parameter Estimates and Summary Statistics for Structural Model of Insurance Purchases, Fertilizer Use, and Soil Erosion 192

Figures Figure 2. 1: Prices of a European Call Option on Futures 38 2.2: Values of an Option on Forward Contracts 40 2.3: Prices of a Put Option on Futures 41 2.4: Prices of a Call Option on Resource Stocks 42 2.5: Prices of a Call Option on Financial Stocks 43 2.6: Prices of a Call Option on the Environment 44 2.7: Prices of a Put Option on Futures 45 5. 1: An Illustration of the Farmer's Decision Problem 86 7. 1: A Sample Elicited Yield Distribution Table 119 8. 1: Effects of Bt Corn on Distribution of Corn Yields in Boone County, Iowa 140 8.2: Effects of Bt Corn on Distribution of Corn Yields in Hall County, Nebraska 140 9.1: Winsorising a Normal Price Distribution 147 9.2: Ratio of Expected Utility for Different Levels of Poor land Distribution and Risk Aversion 155 9.3: Ratio of Expected Utility for Different Levels of Poor land Distribution and Risk Aversion, with the Agenda 2000 Reform 156

Contributors Richard M. Adams Professor, Department of Agricultural and Resource Economics, Oregon State University, USA Bruce A. Babcock Professor of Agricultural Economics and Director, Center for Agricultural and Rural Development (CARD), Iowa State University, USA Robert G. Chambers Professor, Department of Agricultural and Resource Economics, University of Maryland, USA Robert W. Fraser Professor of Agricultural Economics, Imperial College, Wye, UK, and Adjunct Professor of Agricultural and Resource Economics, University of Western Australia, AUSTRALIA. Amir K. Abadi Ghadim, Economist, Farm Business Development, Department of Agriculture, Western Australia, AUSTRALIA Barry K. Goodwin Professor, Andersons Endowed Chair of Agricultural Policy, Trade, and Marketing, Department of Agricultural, Environmental, and Development Economics, Ohio State University, USA. David A. Hennessy Professor, Department of Economics, Iowa State University, USA Greg Hertzler Senior Lecturer in Agricultural and Resource Economics and Associate Dean of Agriculture and Animal Science Faculty of Natural and Agricultural Science The University of Western Australia, AUSTRALIA Terrance Hurley Assistant Professor, Department of Applied Economics University of Minnesota, USA

Contributors Xl Ross Kingwell Visiting senior lecturer, University of Western Australia and Senior adviser, Western Australian Department of Agriculture, AUSTRALIA Joseph N. Lekakis Professor of Resource & Environmental Economics, Department of Economics, University of Crete, GREECE Paul D. Mitchell Assistant Professor, Department of Agricultural Economics, Texas A&M University, USA. David J. Pannell Associate Professor and Principal Research Fellow School of Agricultural and Resource Economics, University of Western Australia, AUSTRALIA John Quiggin Senior Fellow, Australian Research Council School of Economics, Faculty of Economics and Commerce Australian National University, AUSTRALIA HiJd Rygnestad Managing Director, The Rygnestad Group, Sevanna Park T-7C, Ithaca, NY 14850, USA Vincent H. Smith Professor of Economics, Department of Agricultural Economics and Economics, and Co-Director, Agricultural Marketing Policy Center, Montana State University, USA. JunJie J. Wu Associated Professor, Department of Agricultural and Resource Economics, Oregon State University, USA.

Preface Risk Management and the Environment: Agriculture in Perspective is a modern academic work that seeks to bring out both to the private and the policy sectors the importance of risk management in relation to the environment in agriculture, as the world moves towards freer markets. Many efforts were pooled together in making this book. Three years ago, an attempt was made by one of the editors to get a project on 'Agricultural Risk Management and Sustainabilty' (ARMAS) funded by the European Commission. Probably deeming the proposal as prematurely novel for Europe, the Commission's screening experts abandoned its evaluation. Following that experience it became apparent that the literature on the theme ought to be strengthened and emphasized through a book by a well known publishing house. The editorial team was formed relatively quickly and an invitation to known experts in the field for contributions was issued. Subsequently, Kluwer Academic Publishers, evaluated an edited volume proposal package, and final revisions were made prior to submitting the entire manuscript for publication. We are gratefully acknowledging the moral support of several individuals as well as the patience of our publishers. Rethimno, Crete, June 2002 Bruce A. Babcock, Robert W. Fraser, Joseph N. Lekakis