Risk aversion in low income countries: Experimental evidence from Ethiopia

"Production systems in low-income developing countries are generally poorly diversified, focusing on rainfed staple crop production and raising livestock. These activities are inherently risky and investment and production decisions by farm households are therefore made within environments that are affected by risk. Because of poorly developed or absent credit and insurance markets it is difficult to pass any of these risks to a third party. As a result, it is often found that even when the expected net return is high, households are reluctant to adopt new agricultural technologies when they involve risk. Better understanding risk behavior will be essential for identifying appropriate farm-level strategies for adaptation to climate change by low-income farmers. Despite risk's potentially central role in farm investment decisions, there have been few attempts to estimate the magnitude and nature of risk aversion of farm households in low-income developing countries. To partially close this gap, this paper uses an experimental approach applied to 262 households in the Ethiopian highlands with real payoffs. By incorporating both small and large stakes and gains and losses into the experiment, we test for the presence of low stake risk aversion and loss aversion. We find that more than 50 percent of the households are severely or extremely risk averse. This contrasts with studies in Asia where most household decision-makers exhibit moderate to intermediate risk aversion. We find that households that stand to lose as well as gain something from participation in games are significantly more risk averse than households playing gains-only games. This strongly suggests that agricultural extension efforts involving losses as well as gains may face systematic resistance by farmers in low-income, high-risk environments. Promotion of technologies with downside risks – even if the upside potential is enormous – should therefore be combined with insurance or other support. We also find that even without the possibility of losses households are much more averse to risk when stakes are high. Results indicate that insurance or other support can likely be phased out. After initial successes have convinced farmers that technologies are viable, risk aversion declines. There are also significant differences in risk averting behavior between relatively poorer and wealthier farm households, which is consistent with decreasing absolute risk aversion. This suggests that as wealth is built up households are willing to take on more risk in exchange for higher returns. Both these findings suggest a strong path dependence. Efforts to develop poor rural areas through promotion of risky technologies should take this path dependence into account. Early successes are important, but households should also be allowed to build up wealth before they are challenged or tempted to take on more risky ventures. Furthermore, the finding that even without the possibility of losses households are much more risk averse when stakes are higher, suggests that agricultural extension should start modestly before asking households to take on larger gambles." from Authors' Abstractexperimental studies, loss aversion, risk aversion, Risk management, econometric models, Farm households,

The Role of Production Risk in Sustainable Land-Management Technology Adoption in the Ethiopian Highlands

This paper provides empirical evidence of production risk impact on sustainable land- management technology adoption, using two years of cross-sectional plot-level data collected in the Ethiopian highlands. We used a moment-based approach, which allowed a flexible representation of the production risk (Antle 1983, 1987). Mundlak’s approach was used to capture the unobserved heterogeneity along with other regressors in the estimation of fertilizer and conservation adoption. The empirical results revealed that impact of production risk varied by technology type. Production risks (variance and crop failure as measured by second and third central moments, respectively) had significant impact on fertilizer adoption and extent of adoption. However, this impact was not observed in adoption of conservation technology. On the other hand, expected return (as measured by the first central moment) had a positive significant impact on both fertilizer (adoption and intensity) and conservation adoption. Economic instruments that hedge against risk exposure, including downside risk and increase productivity, are important to promote adoption of improved technology and reduce poverty in Ethiopia.Production risk, sustainable land management technology adoption, moment based estimation, Ethiopia

Soil and water conservation technologies: A buffer against production risk in the face of climate change?: Insights from the Nile Basin in Ethiopia

"This study investigates the impact of different soil and water conservation technologies on the variance of crop production in Ethiopia to determine the risk implications of the different technologies in different regions and rainfall zones. Given the production risks posed by climate change, such information can be used by decision makers to identify appropriate agricultural practices that act as a buffer against climate change. Using a household- and plot-level data set, we apply the Just and Pope framework using a Cobb-Douglas production function to investigate the impact of various soil and water conservation technologies on average crop yields and the variance of crop yields, while controlling for several household- and plot-level factors. Results show that soil and water conservation investments perform differently in different rainfall areas and regions of Ethiopia, which underscores the importance of careful geographical targeting when promoting and scaling up soil and water conservation technologies. We find that although soil bunds, stone bunds, grass strips, waterways, and contours all have very significant positive impacts on average crop yields in low-rainfall areas, only soil bunds have significant risk-reducing effects in these areas with low agricultural potential. We also find that irrigation and use of improved seeds have insignificant risk-reducing effects in low-rainfall areas, suggesting that—as currently implemented—these interventions may not be appropriate adaptation strategies for these environments. Regionally, in the low-rainfall areas we find significant spatial heterogeneity, with soil bunds being risk reducing in Oromiya and Amhara, and stone bunds, grass strips, and waterways being risk reducing in the Southern Nations, Nationalities, and Peoples Region. Irrigation was only risk reducing in the high-rainfall areas of Benishangul-Gumuz. These results remain robust even after controlling for the major crops grown on the plot. Results show that soil and water conservation technologies have significant impacts on reducing production risk in Ethiopia and could be part of the country's climate-proofing strategy. However, results also show that one-size-fits-all recommendations are not appropriate given the differences in agro-ecology and other confounding factors." from authors' abstractJust and Pope, Risk increasing, Risk reducing, Stone bunds, Soil bunds, Waterways, Grass strips, Contours, Soil and water conservation, Low-rainfall areas, High-rainfall areas, Climate change,

The impact of climate change and adaptation on food production in low-income countries: Evidence from the Nile Basin, Ethiopia

"This paper presents an empirical analysis of the impact of climate change on food production in a typical low-income developing country. Furthermore, it provides an estimation of the determinants of adaptation to climate change and the implications of these strategies on farm productivity. The analysis relies on primary data from 1,000 farms producing cereal crops in the Nile Basin of Ethiopia. Based on monthly collected meteorological station data, the thin plate spline method of spatial interpolation was used to interpolate the specific rainfall and temperature values of each household. The rainfall data were disaggregated at the seasonal level. We found that climate change and climate change adaptations have significant impact on farm productivity. Extension services (both formal and farmer to farmer), as well as access to credit and information on future climate changes, affect adaptation positively and significantly. Farm households with larger access to social capital are more likely to adopt yield-related adaptation strategies." from authors' abstractAdaptation, Climate change, farm level productivity, rainfall,

Does Adaptation to Climate Change Provide Food Security? A Micro-Perspective from Ethiopia

We examine the driving forces behind farm households' decisions to adapt to climate change, and the impact of adaptation on farm households' food productivity. We estimate a simultaneous equations model with endogenous switching to account for the heterogeneity in the decision to adapt or not, and for unobservable characteristics of farmers and their farm. Access to credit, extension and information are found to be the main drivers behind adaptation. We find that adaptation increases food productivity, that the farm households that did not adapt would benefit the most from adaptatio

Analyzing the determinants of farmers' choice of adaptation methods and perceptions of climate change in the Nile Basin of Ethiopia:

"This study identifies the major methods used by farmers to adapt to climate change in the Nile Basin of Ethiopia, the factors that affect their choice of method, and the barriers to adaptation. The methods identified include use of different crop varieties, tree planting, soil conservation, early and late planting, and irrigation. Results from the discrete choice model employed indicate that the level of education, gender, age, and wealth of the head of household; access to extension and credit; information on climate, social capital, agroecological settings, and temperature all influence farmers' choices. The main barriers include lack of information on adaptation methods and financial constraints. Moreover, the analysis reveals that age of the household head, wealth, information on climate change, social capital, and agroecological settings have significant effects on farmers' perceptions of climate change." from authors' abstractAdaptation, Perception on climate change, Agriculture, Climate change, Nile Basin of Ethiopia,

Impact of soil conservation on crop production in the Northern Ethiopian Highlands:

"Land degradation, in the form of soil erosion and nutrient depletion, threatens food security and the sustainability of agricultural production in many developing countries. Governments and development agencies have invested substantial resources in promoting soil conservation practices, in an effort to improve environmental conditions and reduce poverty. However, very limited rigorous empirical work has examined the economics of adopting soil conservation technology. This paper investigates the impact of stone bunds on crop production value per hectare in low and high rainfall areas of the Ethiopian highlands using cross-sectional data from more than 900 households having multiple plots per household. We use modified random effects models, stochastic dominance analysis (SDA) and matching methods to ensure robustness. The parametric regression and SDA estimates are based on matched observations obtained from nearest neighbor matching using propensity score estimates. This is important because conventional regression and SDA estimates are obtained without ensuring the existence of comparable conserved and non-conserved plots within the distribution of covariates. Here, we use matching methods, random effects and Mundlak's approach to control for selection and endogeneity biases that may arise due to correlation of unobserved heterogeneity and observed explanatory variables. The three methods used herein consistently show that plots with stone bunds are more productive than those without such technologies in semi-arid areas but not in higher rainfall areas, apparently because the moisture-conserving benefits of this technology are more beneficial in drier areas. This implies that the performance of stone bunds varies by agro-ecological type, suggesting a need for the design and implementation of appropriate site-specific technologies." from Authors' AbstractSoil conservation, Crop production, Agro-ecology, Matching method, Stochastic dominance, Modified random effects model, Land management,

Risk, Time and Land Management under Market Imperfections: Applications to Ethiopia

This Ph.D. thesis addresses both theoretical and empirical issues pertaining to land management decisions of farm households in developing countries working under an imperfect market and institutional setting (with case studies from Ethiopia). Using techniques in experimental economics, efforts are also made to assign some quantitative measures to the most important parameters (such as risk and time preferences) in the same decision making process. Paper I: A Dynamic Economic Model of Soil Conservation with Imperfect Markets and Institutions In this paper, we develop a dynamic soil conservation model that explicitly incorporates labor, capital and land market imperfections and their interactions to suit the problems of smallholders in many developing countries. We use the model to analyze the impact of these institutional and market imperfections on the optimal levels of labor allocations into cultivation and conservation efforts. Increased transaction cost in factor markets is found to have a direct impact on soil conservation effort by increasing its shadow prices and curtailing its demand. It also has an indirect impact on soil conservation by affecting the shadow price of the soil stock and hence enhancing or curtailing its demand depending on the initial factor endowments of farm households, the relative strength of conservation and cultivation inputs on the soil dynamics, the profit share of cultivation input, and the degree of interaction across the factor markets. The overall impact is thus inconclusive. Various possible scenarios are explored in the model. Paper II: Risk Preferences of Farm Households in Ethiopia This study measures farmers’ attitudes towards risk using an experimental approach for a sample of 262 farm households in the Ethiopian highlands. We find more than 50 percent of the households in the severe to extreme risk aversion category, with a constant partial risk aversion coefficient of more than 2.00. With careful construction of the experiment, the natures of absolute and partial risk aversion are examined, and our data supports the presence of Decreasing Absolute Risk Aversion (DARA) and Increasing Partial Risk Aversion (IPRA) behavior. The validity of some of the expected utility theory predictions is tested, and the predictions of risk neutrality for smaller stakes and predictions of similar preferences for gains and losses, which stem from the major tents of the theory (concavity and asset integration), are not supported by our experiment. Paper III: Time Preferences of Farm Households in Ethiopia This study measures farmers’ time preferences (subjective discount rates) using an experimental approach with monetary incentives for a sample of 262 farm households in the Ethiopian highlands. The median discount rates are found to be more than 43 percent, which are more than double the interest rate on the outstanding debt. Given imperfect credit markets, household wealth (physical asset) levels are found to be highly correlated to this attitude measure. Time frame and magnitude effects, and delay/speed up asymmetries are anomalies found in the experiment. Paper IV: Market Imperfections and Farm Technology Adoption Decisions: An Empirical Analysis In this paper, we investigate the impacts of market and institutional imperfections on farm technology adoptions in a model that considers fertilizer and soil conservation adoptions as related decisions. Controlling for plot characteristics and other factors, we find that a household’s decision to adopt fertilizers does significantly and negatively depend on whether the same household adopts soil conservation. The reverse causality, however, is insignificant. We also find outcomes of market imperfections such as limited access to credit, plot size, risk considerations, and rates of time preference to be significant factors explaining variations in farm technology adoption decisions. Relieving the existing market imperfections will more likely increase the adoption rate of farm technologies

How can African agriculture adapt to climate change: Risk aversion in low-income countries: Experimental evidence from Ethiopia [in Amharic]

Agricultural production remains the main source of livelihood for rural communities in Sub-Saharan Africa, providing employment to more than 60 percent of the population and contributing about 30 percent of gross domestic product. With likely long-term changes in rainfall patterns and shifting temperature zones, climate change is expected to significantly affect agricultural production, which could be detrimental to the region’s food security and economic growth. An assessment of the factors influencing farm-level adaptation can facilitate the formation of policies and investment strategies that help moderate potential adverse consequences of long-term climate change. Because smallholder farmers tend to have a low capacity to adapt to changes in climatic conditions, policies that help these farmers adapt to global warming and associated climatic extremes are particularly important. This brief is based on a study that assesses smallholder farmers’ adaptation to climate change in southern Africa. The study identifies farmers’ perceptions of climate change and the determinants of farm- level adaptation strategies, and recommends policies that could help stabilize national and regional food production given the anticipated adverse effects of climate change." -- from textNon-PRIFPRI2EPT

Experimental evidence from Ethiopia

Production systems in low-income developing countries are generally poorly diversified, focusing on rainfed staple crop production and raising livestock. These activities are inherently risky and investment and production decisions by farm households are therefore made within environments that are affected by risk. Because of poorly developed or absent credit and insurance markets it is difficult to pass any of these risks to a third party. As a result, it is often found that even when the expected net return is high, households are reluctant to adopt new agricultural technologies when they involve risk. Better understanding risk behavior will be essential for identifying appropriate farm-level strategies for adaptation to climate change by low-income farmers. Despite risk’s potentially central role in farm investment decisions, there have been few attempts to estimate the magnitude and nature of risk aversion of farm households in low-income developing countries. To partially close this gap, this paper uses an experimental approach applied to 262 households in the Ethiopian highlands with real payoffs. By incorporating both small and large stakes and gains and losses into the experiment, we test for the presence of low stake risk aversion and loss aversion. We find that more than 50 percent of the households are severely or extremely risk averse. This contrasts with studies in Asia where most household decision-makers exhibit moderate to intermediate risk aversion. We find that households that stand to lose as well as gain something from participation in games are significantly more risk averse than households playing gains-only games. This strongly suggests that agricultural extension efforts involving losses as well as gains may face systematic resistance by farmers in low-income, high-risk environments. Promotion of technologies with downside risks – even if the upside potential is enormous – should therefore be combined with insurance or other support. We also find that even without the possibility of losses households are much more averse to risk when stakes are high. Results indicate that insurance or other support can likely be phased out. After initial successes have convinced farmers that technologies are viable, risk aversion declines. There are also significant differences in risk averting behavior between relatively poorer and wealthier farm households, which is consistent with decreasing absolute risk aversion. This suggests that as wealth is built up households are willing to take on more risk in exchange for higher returns. Both these findings suggest a strong path dependence. Efforts to develop poor rural areas through promotion of risky technologies should take this path dependence into account. Early successes are important, but households should also be allowed to build up wealth before they are challenged or tempted to take on more risky ventures. Furthermore, the finding that even without the possibility of losses households are much more risk averse when stakes are higher, suggests that agricultural extension should start modestly before asking households to take on larger gambles.Non-PRIFPRI1; Theme 1; Subtheme 1.1; GRP38; not on water page; Global food scenariosEPT