Effects of Government Program Payments on Farm Portfolio Diversification

Abstract

The substitution of capital for labor promotes specialization and results in larger farms capturing size economies. Conversely, when production is labor intensive, farms tend to be smaller and more diversified. Robison and Barry concluded that specialization leads to significant economies of scale that must be expected in order to offset the risk reduction advantage of diversification. In diversifying, the farm sacrifices economies of scale, but tends to stabilize returns at a lower level with the benefit of reduced risk. White and Irwin found that there may exist linkages between size and outputspecialization in United States agriculture. In addition, Pope and Prescott concluded, from a survey of crop farms in California, that as farm firms become wealthier, farms place less emphasis on diversification. While management expertise and many technological advances tend to favor specialization, income uncertainty due to yield and price variability may favor diversification. Such diversification may be viewed as a portfolio investment problem including investment in onfarm enterprise activities and investments off the farm in stock and other financial securities. Government acreage reduction programs also complicate decisions about the ideal farmenterprise activity mix and its relationship to offfarm investments. Further, adjustments in the remainder of the farm portfolio given the availability of government acreage reduction program participation, are not well understood. These issues motivate an analysis of farm versus off-farm asset investment strategies, and the impact of government acreage reduction program payments on risk-efficient investment portfolios.