Do counter-cyclical payments in the 2002 US Farm Act create incentives to produce?

Abstract

Analytical results in the literature suggest that counter-cyclical payments create risk-related incentives to produce even if they are ‘decoupled’ under certainty [Hennessy, D.A., 1998. The production effects of agricultural income support polices under uncertainty. Am. J. Agric. Econ. 80, 46–57]. This paper develops a framework to assess the risk-related incentives to produce created by commodity programmes like the loan deficiency payments (LDPs) and the counter-cyclical payments (CCPs) in the 2002 US Farm Act. Because CCPs are paid based on fixed production quantities they have a weaker risk-reducing impact than LDPs. The latter have a direct impact through the variance of the producer price distributions, while the impact of CCPs is due only to the covariance between the CCP and the producer price distributions. The methodology developed by [Chavas, J.-P., Holt, M.T., 1990. Acreage decisions under risk: the case of corn and soybeans. Am. J. Agric. Econ. 72 (3), 529–538] is applied to calculate the appropriate variance–covariance matrix of the truncated producer price distributions under the 2002 Farm Act. Risk premia are computed showing that the risk-related incentives created by CCPs are significant and do not disappear for levels of production above the base production on which CCPs are paid.