IS THE MARKET FAILING AGRICULTURAL PRODUCERS WHO WISH TO MANAGE RISKS

I. INTRODUCTION The risk faced by agricultural producers mostly is captured by the variability of annual net income levels. This risk is a function of variability in output price, yield, input prices, and input quantities. Yet, the financial tools available to manage some of this risk may be under-utilized. For example, price risk tools (primarily forward cash contracting and hedging with futures or options) and yield risk tools (primarily crop insurance) are not widely used by producers in the United States. This is somewhat surprising considering that the expansive theoretical literature has long asserted that primary commodity producers stand to derive considerable risk-reduction benefit from hedging, forward contracting, and/or insuring. This raises the question, is the market failing to provide agricultural producers with effective risk management tools? If the answer to the question is "no," producers voluntarily are accepting their level of risk exposure, implying that they might be less risk-averse than most research assumes. However, if the answer is "yes," some attributes of the available risk management tools may conflict with the structure of agriculture and/or commodity markets. This would have significant policy implications, especially in light of the current trend toward placing responsibility for risk management on the producer and the market rather than on government, as illustrated by the recent changes in federal crop insurance aimed at eliminating disaster aid programs. This study adopts the Tew et al. (1985, p. 58) definition of "market failure" as "the underprovision of public goods by private market mechanisms." The question of market failure is addressed by comparing producers' demand for price and yield risk management tools with the actual tools available in a sample of California commodity markets. One expects that a market will provide tools that are designed to manage effectively the primary sources of risk faced by producers. Farm managers' needs for specific risk management tools are identified using both historical statistical data and data collected in a survey of producers. II. SURVEY RESULTS REGARDING RISK NEEDS Agricultural producers were surveyed concerning their risk needs. A mail survey with some follow-up interviews was used. Conducted during 1992-1993 across California, the survey generated 569 responses. Respondents were representative of the state's diverse agriculture because, as a whole, they covered a wide geographical and commodity base. Following the example of previous studies (such as Patrick et al., 1985), the survey identified and classified several sources of risk into two general categories: (i) production risks such as pests, drought, floods, freeze, and labor availability and (ii) market risks such as output price, physical factor input cost, and labor cost. Producers were asked to rank the sources of risk in order of importance. The results of this ranking reveal that production risk concerns are second to market risk among producers in California (table 1). Producers ranked output price and input costs as first and second, respectively, among their risk concerns. However, the significant number of responses received by each of the detailed types of risk listed in the table indicate the detail of producers' concerns. It is not just "price" or "yield" that concerns individual producers. This, in turn, indicates a need for varied and detailed risk tools. The concern for output and input price risk expressed in the survey leads to expectations of high levels of use of price risk management tools. However, the data show that a small minority of producers use each of the risk management tools that directly affect price: 23.4% use forward contracting and 6.2% are hedging. Similarly, the rankings for the many sources of yield risk listed in table 1 (disease, drought, etc.) make the low level of usage for crop insurance (24.4%) somewhat surprising. …