Risk and crisis management in agriculture – On the role of government in handling yield and price risks –

By Scientific Advisory Board on Agricultural Policy at the BMELV*

A great deal supports the fact that in some sectors of European agriculture, in future agricultural entrepreneurs will have to deal more with risk management, in particular the trend towards increasing price and yield risks with their respective consequences for the farmers’ income. One fundamental insight from the previous considerations is that handling price and yield risks is primarily the job of the entrepreneur, which must be dealt with in view of the local requirements, the specific risk exposition and the individually perceived risk. Collective, sector-wide stabilization instruments, such as previous EU agricultural policy with intervention prices, state warehousing and variable export restitutions or import absorptions do not live up to this task. They are not targeted enough and incur unjustifiably high fiscal and national economic costs. The failure and the reduction of these traditional market regulation instruments therefore not only triggered a fundamental debate about the role of government in the risk management of agricultural entrepreneurs, but also intensified the search for targeted, state promotional measures accompanying private economic commitments. The suggested subsidization of premiums for harvest damage insurance even in Germany is an example of handling yield risks. In cases of price risks and their consequences for income there are additionally other proposals such as a risk equalization reserve, greater regulation of commodity futures markets and retention of direct payments as income stabilizing elements.

In overall risk management the state’s task should be to ensure that single entrepreneurs are provided with as broad a spectrum as possible of both internal and external private risk management instruments. Risk exposition and risk aversion are heterogeneous for individual farms and persons, making any collective set of instruments or singled out state support of one single private-business instrument crowd out other options or instruments and thus economically inefficient. This basically speaks for support measures with a sense of proportion and time limits as well as for strengthening market forces through supporting information, creating transparency and providing infrastructure. With regard to the current proposals on the role of government in handling yield and price risks and in consideration of the arguments presented, the Advisory Board reaches the following recommendations. 50. The Advisory Board deems long-term subsidization of multiple-risk insurance, as practiced in the USA and some EU member states, financially and economically unjustifiable. Practice shows that the valid economic insurance principle is given up for risk management instruments and purely transfer instruments evolve. The Board does, however, think the state should take action for typical systemic risks such as drought and flooding with previously unknown probability distributions for their incidence (so-called real uncertainties).

A chronologically diminishing, sliding premium subsidy for drought risks that would expire after an adequate period of time could help to lower the high market introduction costs of insurance products, to correct the systematic underestimation of these climate-related risks on behalf of the farmers and to gather more information about the quantity and extent of such extreme weather events. Such a temporary premium subsidy as market introduction aid could be set up under the second pillar in compliance with the WTO under the category "new challenges" and appropriately co-financed as the most recent proposal of the EU Commission for the CAP after 2013 also envisages. The previous provision whereby member states may grant co-financed subsidies for insurance premiums in the scope of their target ceilings for direct payments (first pillar) would have to be dissolved. Setting up this support measure under the second CAP pillar would have the advantage that in some countries experience could initially be gained in terms of a pilot project and considerations made with other stabilizations measures of the second pillar and, if successful, these could be transferred to further regions. The Advisory Board considers state participation in the privately managed reinsurance business beyond a specific insured sum or a blend of premium subsidies and reinsurance activities by the government a possible alternative. The premium relief for farmers would largely be equal to the effect of a pure premium subsidy. Differences would only result for the tax authorities with regard to amount, frequency and occurrence probability of necessary payments. Perhaps the Länder in cooperation with the insurance industry could also be allowed to decide what form of state grant they wish to implement.

The Advisory Board deems the introduction of a purely state drought fund, e.g. from funds of the first CAP pillar, without the participation of the insurance industry and tied to a weather index as problematic. Unlike private insurance policies, state fund solutions would probably not be able to contain any liability guarantees and short funds in the EU budget could then make insurance protection quite questionable. For the rest, pure index-based solutions lead away from the insurance business principle, whereby actual, individual damages should be compensated. By contrast solutions using weather derivatives inevitably lead to over- or under-compensation if an additional loss appraisal by professionals is not conducted, as for example in the Austrian model.

EU state aid law was established in order to avoid intra-Community distortions of competition. It monitors national unilateral routes and defines in some cases strict ceilings for admissible benefits, as in the agricultural sector, with the objective of gradual Community-wide harmonization of subsidy and fiscal legislation. Therefore, the 19 % taxation of multiple-risk insurance policies in Germany alongside tax relief and tax exemptions in other EU member states should be seen critically. Nevertheless, in Germany the fiscal policy principle of equal treatment of sectors and products applies, which allows for only a few exceptional cases. Since the Advisory Board is fundamentally critical of special sector-specific provisions in other cases as well, it recommends that the 19 % insurance tax be retained for multiple-risk insurance in Germany and that tax benefits in other EU countries be abolished.

In addition to traditional EU market regulation policies, state direct disaster aid has proven an effective constraint for the establishment of adequate private insurance solutions. Therefore, we should speak up for abolishing such aid. However, we cannot seriously assume that politics would waiver this instrument, especially in the case of entirely new damage events. The Advisory Board therefore recommends continuing to apply the existing provision of at first cutting the maximum rates of compensation for direct aid by 50 % and later to examine the 50 %.

The Advisory Board does not consider the proposed risk equalization reserve as a substitute for crop insurance, because it is meant more to serve towards smoothing basically positive incomes and not towards avoiding economic situations that threaten farmers’ livelihoods. We do, however, continue to have doubts with regard to compatibility with EU state aid law and the WTO provisions as well as the fiscally different treatment of different holdings within agriculture and the establishment of new special circumstances for agriculture. Only when these doubts are eliminated could we consider the introduction of a risk equalization reserve as a supplemental instrument for income smoothing, however not as a sector-specific but as a general fiscal policy measure. The Scientific Advisory Board is against the introduction of a sector-specific risk equalization reserve.

The Advisory Board is critical of reinterpreting direct payments as an instrument of risk management in the sense of income stabilization. It is beyond dispute that direct payments trigger a shift in income levels and therefore lessen the probability for falling below the subsistence level. Yet for this instrument the same main objection applies as for classical market regulation policies that it is not tailored to the specific risk situation of single holdings and farm operators, but on the one hand is effective collectively and across-the-board and on the other hand does not encompass certain production areas at all. For the rest, the level stabilizing effect can be lessened through shifts and, under certain conditions, even be entirely eliminated.

The Advisory Board is critical of stricter regulation of commodity futures markets with the aim of market price stabilization, as presently proposed by scientists for international agricultural commodities markets (global virtual reserve) and also by two EU commissioners for the EU markets. Dynamic price ceilings and price floors for futures prices cannot be defined by governments or experts to eliminate alleged excessive speculation. For the rest, the destabilizing effect of excessive speculation on the futures markets on spot prices has not yet been empirically proven. Further research is needed here. To derive far-reaching intervention in the pricing mechanism based on the present findings is not justified according to the Advisory Board. Rather, it sees the danger that such interventions will be misused for distributional policy purposes. Historical experiences with international market and price stabilization policies are also rather negative. Professional handling of price risks ultimately is one of the core tasks of entrepreneurs in market economy systems. This also applies to the agricultural and food industries. Some segments of the agricultural sector prove quite clearly that this can be mastered successfully.

With regard to a globally organized, but decentralized physical food reserve also proposed to protect consumers as well as a safety net to be established in the EU to protect producers, e.g. in the form of aid for private warehousing activities or of temporary liquidity assistance, the Advisory Board thinks further discussion and research are needed. Besides the proven proposals, as many as possible new instruments of risk management should be examined for the effectiveness and efficiency to battle hunger and poverty in the world and to avoid endangering livelihoods through extreme market distortions.

Promotion of biogas production by means of the Renewable Energy Sources Act (EEG) opinion on the planned amendment of the EEG

By Scientific Advisory Board on Agricultural Policy at the BMELV*

By presenting this opinion, the Advisory Board states its views on a special segment of bioenergy policy: the promotion of biogas production by means of the Renewable Energy Sources Act (EEG). This was prompted by the Federal Government’s plan to amend the EEG before the end of this year.

This is the second time that the Advisory Board comments on the Federal Government’s bioenergy policy. The opinion follows the comprehensive expert opinion from 2007. The Advisory Board believes that the basic assessments and recommendations made in this opinion are still valid. This includes the assessment that solar and wind energy is expected to increasingly gain ground in the second half of the century within the portfolio of renewable energies and that technological progress will make a concentration on efficient energy technologies increasingly attractive at the expense of support on a broad base.

The Advisory Council believes that the current promotion of biogas through the EEG is linked to a number of disadvantages. It is not convincing in terms of climate policy due to very high carbon avoidance costs and its prospects of bringing about drastic technological changes and the resulting cost reductions are very limited. It can only make a relatively small contribution to energy supply. At the same time, it causes problematic changes in the agricultural structure and makes agriculture dependent on policy again. Finally, it tends to increase agricultural prices, thus putting a strain on consumers.

With respect to the general orientation of the EEG, the Advisory Board recommends that the core idea behind the EEG should be to promote the technological development of various renewable energy sources so as to significantly improve their efficiency and to reach the competitive threshold within a reasonably short period of time. Bioenergy technologies with carbon avoidance costs well above 100 € per ton and no clearly visible improvement in the course of time should not be supported any more. With regard to the other bioenergy technologies, it should be explicitly stated which specific targets the promotion is expected to reach and by when. The evaluation enshrined in the EEG should primarily be targeted at assessing the different bioenergy technologies on the basis of their carbon avoidance costs and the way they have changed over time.

All in all, the Advisory Board concludes that the promotion of biogas production should not be continued in its current form. With respect to the future orientation of the promotion of biogas within the EEG, the Advisory Council recommends, among other things, to abolish the bonus for biogas from renewable resources for new installations. The basic remuneration should be maintained and the slurry bonus significantly increased in order to promote the construction of "pure" slurry plants. However, the slurry bonus should only be envisaged for plants using a minimum of 95 % mass fraction of slurry. The Advisory Council believes that a scaling of the slurry bonus according to the plant size is worth considering. The remaining bonuses should be abolished as their regulatory effects in the past have been limited.

Identification of peripheral regions with structural and economic problems in Germany

By Anne Margarian and Patrick Küpper, Braunschweig

We outline our work on the identification of about 20 structurally lagging regions for the pilot project "LandZukunft". Since the main goal is in the selection of regions facing the largest challenges, a ranking approach is chosen. We construct selection criteria based on selected indicators with a factor analysis. Thereby, 16 indicators are condensed to the dimensions "social inclusion", "economic performance and structure" as well as "spatial remoteness". We refrain from an aggregation of these dimensions since this weighting problem cannot satisfactory be solved. We select those regions that belong to the last quarter within all three dimensions. The separated calculation for western and eastern Germany results in the identification of 12 regions in the west and 5 in the east. We show that the selected regions due to compensatory effects in index-construction are not structurally comparable in every respect. Due to the open thematic definition of project objectives, a different selection of indicators would also be defendable. This could possibly result in a different selection of regions. Nevertheless, with our approach theoretical reflections and statistical criteria minimize subjective elements in the selection process and enable its transparent communication.

Evaluating the benefits of site-specific nitrogen fertilization for cereal crops by means of a decision theory approach

By Friedrich Kuhlmann and Stefan Neumann, Gießen

The benefits of site-specific nitrogen fertilization strategies for cereal crops are usually evaluated on the basis of field experiments. This paper, in contrast, presents a model that is based on decision theory. The model captures the decision situation – characterized by incomplete information on the expected supply levels and the spatial and temporal variability of non-controllable growth factors (notably soil water storage capacity and precipitation) – farmers are actually facing when taking decisions about the level of nitrogen fertilization.

First of all, the model is applied to assess nitrogen fertilization benefits under the assumption that the farmer possesses complete information about the non-controllable growth factors. The result marks the theoretically achievable upper limit. The benefits are specified for the decision criteria "gross margin", defined as crop revenue free of nitrogen costs (profitability aspect), "standard deviation" (risk aspect) and "unused nitrogen" (environmental sustainability aspect).

Then the benefits of various uniform field treatment and site-specific fertilization strategies are calculated. As a principle, the additional benefits of site-specific strategies lie within the narrow margin between the fertilization result in the case of the availability of complete information as its upper limit and the result of the "best" uniform field treatment strategy as its lower limit.

The model calculations show that the additional benefits of site-specific fertlization strategies are marginal or non-existent, taking into account the extent of the spatial and temporal variability accompanying the non-controllable growth factors in the majority of fields as well as the additional costs for site-specific nutrient applications. This also explains the hesitant adoption of site-specific strategies by the farming community.

In addition, the model calculations revealed another result: Considering the normal distribution of the annual precipitation when taking decisions about fertilization levels constitutes a simple and free of charge means to substantially improve the economic efficiency of both uniform field treatments and site-specific fertilisation strategies.

Dairy cattle breeding in the former East Germany – a retrospective evaluation

By Wilfried Brade, Hannover

The ‘breeding-political’ division of Germany ended with the reunification in 1990. The cattle breeding associations liquidated in the former East Germany have been successfully re-established. The separate, centralized, dictatorial breeding program (Black Pied Dairy Cattle breeding) was terminated.

The successful implementation of modern Holstein breeding programs, focusing on efficient milk protein production, in the five new federal states is clearly shown, e.g. if all federal states are compared with regard to the average amount of milk per cow.

The reunified German cattle breeding sector can already be regarded as a great success based on the developments initiated in the new federal states since 1990.

Keywords: cattle breeding, milk production, German Holsteins, reunification

Development of the production and income of bull-fattening enterprises under the influence of the decoupling of the direct payments

By Werner Kleinhanß, Braunschweig

The economic conditions of beef production during the last 10 years were considerably influenced by the BSE crisis and the decoupling of direct payments. The German FADN data is used to analyse the development of production and income of specialized bull fattening farms. Beside the negative impact of the BSE crisis, production also decreased when decoupling was implemented, and partially recovered due to rising beef prices, particularly on medium and large sized bull-fattening farms of the upper income quartile. The income situation of small and low-performance farms was extremely unfavourable, expressed by a substantial percentage of farms with negative incomes, a tense liquidity situation and negative net investment. Only the medium and large companies of the upper performance classes show a positive income development. About one third earn high profits of more than 30 k €/AWU. But these farms must expect a 50 % cut in direct payments in the period up until 2013 due to the implementation of uniform regional area payments, with a decline in profit on a similar scale. If one considers the increasing competition from the Biogas sector, there would seem to be a high probability that the beef producers that have hitherto been the most competitive will move away from beef production.

Measurement of the supply of agricultural products: international comparison and need for development

By Christian Klapp and Ludwig Theuvsen, Göttingen

Recently the supply situation in respect of agricultural products has received growing attention due to, for instance, the rising demand for animal products, growing use of biomass, climate change, etc. Therefore, an appropriate method for calculating the total output of agricultural production is required. Despite the need for such a system, existing Natural Accounts for Agriculture, which are often based on the traditional cereal unit, have come under severe pressure to adapt since they do not take into account either the growing use of biomass for energy production or environmental factors. Therefore, this paper provides an international comparative overview of procedures for aggregating agricultural production in order to gain ideas for the further development of the system currently applied in Germany.

Shortcomings of political instruments for agricultural soil conservation

By Nina Hagemann, Leipzig and Katrin Prager, Aberdeen

Soil degradation results in long-term damage of soil structures which causes income loss for farmers and has negative ecological and social impacts. The article is based on a case study carried out in the Uckermark region (Brandenburg) that has been conducted as part of the EU research project "Sustainable Agriculture and Soil Conservation" (SoCo). SoCo is aimed at analysing the design and implementation of current political instruments in different EU Member States. In the case study area Uckermark, empirical data have been collected through face-to-face, semi-structured interviews exploring the design, implementation and monitoring of policies for agricultural soil conservation.

Both document analysis and interviews indicate that there are deficits in practical soil conservation despite the fact that a range of policies for soil conservation exist. Due to the complex nature of soil degradation it is not possible to link soil conservation effects to individual policies. We therefore base our arguments on the analysis of the requirements of existing instruments and their assessment by local and regional actors. The study shows that the current soil conservation policies only partially address soil degradation issues. This is mainly due to a lack of capacities in the responsible administrations, insufficient design and implementation of the legal requirements, and – in the Uckermark – a lack of regionally adapted incentive schemes. At the same time, the paper provides options for a more effective implementation of soil conservation measures.

^* Members of the scientific advisory board: Folkhard Isermeyer, Braunschweig, Annette Otte, Gießen, Jürgen Bauhus, Freiburg, Olaf Christen, Halle-Wittenberg, Stephan Dabbert, Hohenheim, Matthias Gauly, Göttingen, Alois Heißenhuber, München, Jürgen Heß, Kassel, Dieter Kirschke, Berlin, Uwe Latacz-Lohmann, Kiel, Matin Qaim, Göttingen, Michael Schmitz, Gießen, Achim Spiller, Göttingen, Albert Sundrum, Kassel, Peter Weingarten, Braunschweig

Released 17. Nov 2011 as article