Policy objectives

Governments that seek to spur growth and eradicate poverty almost inevitably mix economic policies meant to enhance efficiency and growth with social policies meant to address poverty and vulnerability. Governments also often pursue equity or income redistribution objectives, ttus, government policies related to agriculture and rural areas tend to pursue the following objectives:

• Growth. Economic growth in rural areas-particularly, higher agricultural yields and value-added processing as well as development of off-farm activities-is perceived to be the best way out of poverty in the medium-term. While better in centives for market players and an enabling infrastructure are key drivers, better management of agricultural production risk is also critical for growth, as it enhances access to credit and adoption of new technologies.

• Reduction of poverty and vulnerability in rural areas. To achieve social and equity goals, governments directly intervene in a targeted manner, because free markets do not necessarily alleviate poverty for those in society who cannot effectively participate in them. Safety nets provide one tool for such government intervention.

Implementing policy objectives

Given the limited resources in developing countries and the existence of other sectors requiring government attention, these objectives are typically pursued within an environment of binding fiscal constraints, tte two objectives target different segments of the rural population and different risk profiles. Growth objectives focus on increasing profitability so that less poor farmers can continue adopting production technologies even when high-frequency, low-consequence loss events occur. Poverty reduction policies seek to increase the average income of poor farmers, thus decreasing the volatility of their income and the likelihood that a risk event will wipe out hard-won asset gains.

A precondition for achieving sustainable growth and poverty reduction is an exante system for disaster risk management. Disaster risk management covers severe and very infrequent events affecting mostly the poor, because the poor are more vulnerable and tend to live in marginal and more risk exposed areas. Susceptibility to and the experience of major natural disasters tend to trap people in poverty, due to the lack of efficient risk management at the household level. Government disaster challenge is to deliver timely and predictable aid in disaster situations, ttis requires ex-ante planning rather than just ex-post disaster responses, ttis also implies efforts to forestall political demands for ex-post, ad hoc government disaster assistance. Indeed, a credible and reliable disaster risk management system can put farmers and countries on a higher growth path by making people more comfortable with taking calculated and protected risks.

Naturally growth and poverty-reduction objectives overlap, but this makes it even more important to identify clear objectives and to design effective and cost-efficient ways to achieve them. Mixing objectives can lead to suboptimal outcomes. Many government-facilitated crop insurance programs, for example, attempt to accomplish social welfare and economic efficiency objectives simultaneously. Subsidies

Governments frequently subsidize agricultural insurance products, ttese subsidies take a variety of forms, tte government may co-finance insurance purchas ing with direct premium subsidies, reimburse primary insurers for administrative or product development costs, or provide reinsurance at below-market premium rates. Regardless of the form, government subsidies are generally designed to increase insurance purchasing by lowering the premiums charged to agricultural insurance buyers. Such subsidies are extremely controversial, and for some, are seen to benefit operators of larger farms more than those of smaller farms. A wide range of stakeholders can and will engage in rent-seeking once subsidies are introduced. Subsidies are costly to maintain and are subject to close scrutiny regarding social costs versus social benefits. Many times, subsidies are provided based on the rationalization that agricultural insurance markets are missing or incomplete, without careful consideration of the core reasons why such market limitations exist, ttis document has carefully considered why agricultural insurance is missing or incomplete in many settings: adverse selection and moral hazard, high transaction costs, cognitive failure and ambiguity loading, and exposure to highly correlated loss events. Any government subsidies should be carefully targeted to address one of these specific sources of market failure. Even then, however, the costs of addressing that market failure may simply be too high to justify use of limited government resources to that end. tte rents resulting from even the most carefully targeted subsidies can still be captured by politically powerful elites. Government insurance subsidies may crowd out demand for private sector risk transfer instruments. Any efforts to facilitate the provision of risk transfer instruments should be based on careful consideration of whether subsidies or grants can be provided without distorting or inhibiting the growth of private sector financial markets.

Some types of subsidies are likely to be less distorting than others. Subsidies and grants for supporting financial intermediaries and financial infrastructure, such as technical assistance and data systems needed to develop effective index insurance products, generally create little distortion. Beyond distortions in the markets, legitimate reasons exist for supporting infrastructure to improve market access among the rural poor. Finally, some public support for product development maybe justifiable because of the free rider problem. Innovative insurance products are costly to develop, yet it is difficult to recoup these costs in a competitive market. Any firm can simply copy and compete with the new product without the expense of recovering product development costs. Unfamiliarity with index insurance products can heighten these problems in many developing countries. Examples of subsidies for financial intermediaries and infrastructure include:

• Providing technical assistance to financial intermediaries to improve systems that enhance efficiency, such as management information systems;

• Developing and introducing demand-driven products on a pilot basis;

• Helping to develop or improve service delivery mechanisms that enable greater outreach into rural areas;

• Covering a portion of the cost of establishing new branches in areas lacking financial intermediaries to serve the poor;

• Creating capacity within regulatory and supervisory bodies;

• Supporting the creation of industry associations;

• Developing training institutes and insurance information agencies;

• Supporting data for weather stations or other data to be used to develop effective indexes; and

• Providing technical assistance to develop new products in an emerging market in developing countries.

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