Risk and Risk Management in Agriculture

To set the stage for the discussion on how to deal with risk in agriculture, we classify the different sources of risk. Agriculture is often characterized by high variability of production outcomes, that is, by production risk. Unlike most other entrepreneurs, agricultural producers cannot predict with certainty the amount of output their production process will yield, due to external factors such as weather, pests, and diseases. Agricultural producers can also be hindered by adverse events during harvesting or collecting that may result in production losses. In discussing how to design appropriate risk management policies, it is useful to understand strategies and mechanisms employed by producers to deal with risk, including the distinction between informal and formal risk management mechanisms and between ex-ante and ex-post strategies.

As explained in the 2000/2001 World Development Report (World Bank 2001), informal strategies are identified as "arrangements that involve individuals or households or such groups as communities or villages," while formal arrangements are "market-based activities and publicly provided mechanisms." tte-ex ante or ex-post classification identifies the time in which the response to risk takes place: ex-ante responses take place before the potential harming event; ex post responses take thereafter. Ex-ante informal strategies are characterized by diversification of income sources and choice of agricultural production strategy. One strategy producers employ is risk avoidance. Extreme poverty, in many cases, makes producers very risk-averse, pushing them to avoid high-risk activities, even though the income gains to be generated might be far greater than those gotten through less risky choices, ttis inability to accept and manage risk respectively reflected in the inability to accumulate and retain wealth is sometimes referred to as the "the poverty trap" (World Bank 2001).

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