Climate, Insurance and Innovation: The Case of U.S. Agriculture

Abstract

Innovation and insurance are two important options for the agricultural sector to adapt to climate change. However, how these two options interact with each other has not been documented in the literature. This paper intends to fill this gap by investigating the effects of crop insurance on agricultural innovation in the context of climate change. We first develop a conceptual framework that models the effects of climatic risk and crop insurance on farmers’ demand for innovations, from which the market equilibrium of innovations is then derived while holding the supply curve constant. Hypotheses developed under the conceptual framework are tested by using data for agricultural innovation, climate, and crop insurance associated with ten major field crops in the United States over 1980-2013. We estimate a Poisson fixed effects model via Generalized Methods of Moments (GMM) approach to address the issue of non-strict exogeneity of regressors. We find empirical evidence that the U.S. agricultural sector responds to climate change by increasing innovation activities; but the response is weakened by heavily subsidized crop insurance programs by about 23.3%. This indicates that crop insurance may have an unintended crowding out effect as an option to adapt to climate change and may inhibit societies’ capacity to adapt to climate change in the long-run. Such an effect may also exist under flood and earthquake insurance because similar to crop insurance, these two types of insurance act as alternative risk management options to risk-mitigating innovations.