Risk sources in agriculture

The sources of risk that affect agricultural production are numerous and diverse. They comprise a wide scope of independent events which are linked to each other.

Some of these events are restricted to agricultural business, and others are related to the individuals who operate the farm business (Miller et al. 2004; Aimin 2010). In general, farming is involved in natural, economic, political and institutional environments which create many types of risks (Pingali 2001; Hanson et al. 2004). As can be seen in most of related literature, the categorization of risk sources varies depending on the study objectives.

However, the simplest classification of risk in agriculture was introduced by Hardaker et al.

(1997), who distinguished two main risk sources; business risks, which are directly associated with the variability of farm profitability, and financial risks, which directly affect net cash flows to farmers’ equity. Business risks include the following sub-risks: production, market,

human and institutional risks, while financial risks are related to the way that farms are financed. This simple classification was adopted by Baquet et al. (1997), Kay and Edwards (1999) and Huirne et al. (2000).

Risk sources in agriculture reflect each other. Thus, this issue must be considered carefully when building a whole farm plan. The institutional risk could lead to a change in subsidized prices, and it affects market risk. Likewise, institutional and human resources risks have an impact on production risk. Risks of all categories have an effect on net farm income;

consequently they linked to the financial risk category (Pellegrino 1999; European Commission 2001).

Production risk

It is called yield risk which distinguishes agricultural production (plant and livestock) from other business sectors. It is the essence of risk in agriculture which concern losses arising from the unpredictable nature such as biological, ecological, and technological changes. Farming is affected by production risk which is often related to weather phenomena including flood, insufficient rainfall, frost, overheating, hail, windstorms, diseases and insects.

Given that the agricultural production are more sensitive about the environment effects, timing of some climate aspects are very important. The precipitation at the seed time is luck, but at harvesting is ordeal (Musser 1998; Harwood et al. 1999; Huirne et al. 2000). Losses caused by production risk could be covered by some mechanisms such as insurance, while its negative impact is prolonged by the interruption of normal farm activity that often follows specific catastrophes such as flood and fire. Development and adoption of new techniques and production methods are considered as one of production risk. New crop varieties, chemicals, crop rotations, models of machines may cause losses while they are proving their appropriateness and effectiveness in different agricultural systems (Miller et al. 2004).

Market risk

Market or price risk is associated with the changes of input and output prices arising from unpredictable competitive markets, particularly when these changes occur after the production plan has been taken (Hardaker et al. 1997; Harwood et al. 1999).

The price changes result from different sources, such as world market prices, interest rates, supply and demand variations, quality requirements, shipping problems, change of consumer behavior and policy development. The governmental interventions in the

agricultural market as well as subsidy policy lead to considerable price variability. Trade liberalization is translated by a wide world price risk for the objective commodities (Anderson 1997). The expected damage resulted by market risk aggravate developing countries because of the limited access to futures and options markets which provide information needed for agricultural operation management (Heidelbach 2007). Furthermore, price peaks can endanger food security, whereas low prices threaten farm profitability and farm family incomes.

Human resource risk

Farm operators may themselves be a source of risk in the farm business since the health, the continuing ability to work and the death of the farm owner or the divorce status in the farm family may threaten farming continuity. Consideration of human resources risk is an important issue in risk management procedure, particularly in the case of big size farms and more complex technology. Furthermore, the rapid growth of rural population worldwide accompanied with a shallow skilled rural labour may cause severe losses to production and/or substantially increase costs (Musser 1998; Harwood et al. 1999).

Institutional risk

This type of risks represents the negative impact of changes in policies and legislation on agricultural business. It embodies the political risk by the national governmental interventions in the agricultural sector such as regulations restricting the use of pesticides in horticulture, and use of drugs for disease prevention and treatment in animal husbandry sector. Also, it includes regulations which result in increasing market liberalization and decreasing subsidy levels. Legislation which control land and water use, as well as area licenses, might affect farm profitability. The agricultural output prices are also subjected to foreign trade agreements. Furthermore, agricultural business is indirectly affected by policies and regulations which are not specific to the agricultural sector, such as monetary and fiscal policies, occupational health, patent rights, genetic engineering and environmental regulations (Hardaker et al. 1997; Musser 1998; Huirne et al. 2000).

Financial risk

Financial risk is related to farm capital and farming finance (Harwood et al. 1999). It is reflected in the variability of the net cash flows which can lead to insufficient liquidity and

loss of equity. Consequently, farmers are unable to meet preceding claims on their operations (e.g., debt servicing commitments) with cash generated by the farm business. (Martin 1996).

Musser (1998) suggested three dimensions of financial risk, i.e. interest rate, liquidity, and solvency. The fluctuations in interest rates are ranked as a crucial risk source in agriculture since bank loans are often the main financial supplier, due to farmers’ capital scarcity needed to agricultural investments. Furthermore, the loans’ period and repayment deadlines are not always corresponded with the farming cycle (Nguyen 2007).

3.2.1. Farmers perceptions of risk sources

In fact, farmers’ risk realization varies substantially, and scholars repeatedly addressed farmers’ preferences of risk variations. According to previous empirical studies, there is no agreement about the risks that have a priority for farmers.

Boggess et al. (1985) indicated that rainfall variability, pests and diseases, and crop price variability were the primary risk sources for crop farmers in northern Florida and southern Alabama. While, prices, diseases and weather variability were ranked as most important risk sources for livestock producers in the same study sites.

Patrick et al. (1985) concluded that the weather variability, input costs and output prices were the three most important risk sources for both crop and livestock operators in 12 American states. On the other hand, the participants who were discovered by Knutson et al.

(1998) in Texas and Kansas, listed price as well as yield variability, and input costs as particularly high. Severe drought and meat price variability caused the greatest worries for cattle farmers in Texas and Nebraska, who were studied by Hall et al. (2003).

The results obtained by Martin (1996) revealed that market risk was ranked as a crucial source of risk by all interviewed farmers in New Zealand, The human risk related to accidents or health problems was perceived moderately. Price and production risks were identified as the most important sources of risk in dairy farming, which was studied by Meuwissen et al.

(2001) in the Netherlands.

Agricultural policy followed by the changes in output costs and economic situation were the most relevant risk sources which threaten the agricultural production in Cukurova region of Turkey (Akcaoz and Ozkan 2005). South African sugarcane farmers, studied by Nicol et al. (2007), perceived land institutional risks that were represented by reform regulations and labour legislation as highly relevant risk sources. Production risks represented by coffee berry disease and coffee wilt diseases and market risks such as output and input

prices were the most relevant risks which were perceived by Ethiopian coffee farmers (Ejigie 2005).

Schaper et al. (2010) demonstrated a wide range of risk perceptions among dairy farmers in five European countries. Increasing feed prices, increasing land rents and reduced land availability had the priority among the German dairy farmers. Farmers in France, Ireland and the Netherlands perceive institutional risks highest. Whereas, Swiss farmers gave production risks a higher importance than institutional and market risks.

The unexpected variability of input and output prices, and diseases and pests that affect plants and animals were classified as the most harmful injurious risk sources that threaten the smallholder farmers in Thailand (Aditto 2011).

3.3. Risk management in agriculture