Squeaky Wheel Gets the Oil: Incentives, Information and Drought Policy

Abstract

AbstractMost economic assessments conclude there is no economic efficiency case for governments to provide drought assistance. However, significant public funds are allocated to farmers during droughts and there is a second‐best case to improve drought policy design. In this article we show that the National Drought Policy suffers from adverse selection, moral hazard, incentive compatibility and government commitment problems. We use ABARE farm‐level data that suggest that at least adverse selection was a problem in Victoria during the 2002‐03 drought. These results are replicated at the national level. The current approach of the Commonwealth and state governments is ineffective because it is very difficult to design an efficient and fair drought policy that relies on ex post revelation of information. An alternative approach is investigated where incentives are designed so that farmers self‐select into one of a number of drought policy agreements consistent with their capacity to prepare for drought.