Agricultural Decisions After Relaxing Credit and Risk Constraints

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agricultural_decisions.pdf

The investment decisions of small‐scale farmers in developing countries are conditioned by their financial environment. Binding credit market constraints and incomplete insurance can reduce investment in activities with high expected profits. We conducted several experiments in northern Ghana in which farmers were randomly assigned to receive cash grants, grants of rainfall index insurance, or a combination of the two. We find very strong responses of investment in agriculture from the insurance. In two subsequent years, rainfall index insurance (sometimes coupled with cash grants) was sold to farmers at randomized prices. Demand for index insurance is strong, farmers with insurance invest significantly more on their farms, and increased insurance is associated with riskier production choices in agriculture. Both investment patterns and the demand for index insurance are consistent with the presence of important basis risk associated with the index insurance, and with imperfect trust that promised payouts will be delivered. Demand for insurance in subsequent years is strongly increasing in a farmer’s own receipt of insurance payouts, and with the receipt of payouts by others in the farmer’s social network.