World Bank/ Agro Asemex Comprehensive Management of Agricultural Climate Risk

1. World Bank/ Agro AsemexComprehensive Management of Agricultural Climate Risk Rodney Lester, Cuidad de Queretaro Mexico, October 9, 2008

2. The climate change debate can take some bizarre turns Skippy for dinner Who We Are: How to make Australians eat kangaroo. Source: Garnaut Report, Ch 22 – recommending that 240 million kangaroos replace 7 million beef cattle and 36 million sheep by 2020 to reduce methane emissions

3. A: The current big picture – balanced thinking versus dooms-dayers

4. My take1: Climate change is occurring’ and there is a human effect, but there is huge uncertainty in models Kyoto, Stern etc are poor trade offs for current and next few generations in an economic sense and are not politically acceptable The sensible debate is now about priorities and trade offs, and a key issue is the real shadow price of atmospheric carbon ($2 to >$100) There is a battle going on between an ‘end of the world’ group and economic rationalists 1. Not necessarily WB policy

5. Copenhagen Consensus Priorities www.copenhagenconsensus.com/Default.aspx?ID=788

6. B: The current ag. risk picture – not much regional change in the short/ medium term (except Africa?), and not much aggregate change long term but ……..

7. Impact of CC is highly complex – Macaulay Institute/ ISCI Two marginal sites – Italy, Scotland – 2030 and 2090 Demonstrates highly complex nature of interactions – e.g earlier cropping of grains but reduced biomass because of shorter period to maturity More heterogeneous rainfall distribution Increased productivity for heat loving crops (tomatoes etc) but increased water demand Likely need to change rotation systems – and some crops may become non viable Increased yield variability www.macaulay.ac.uk/LADS/papers/British_Council_report.pdf

8. IPCC 4 sees mixed CC medium term impacts in Latin America Source: IPCC 4, Synthesis Report

9. ODI also sees increased volatility Not much change in average yields in the short term (next 20 years) except Africa, but frequency and severity of extreme events is likely to increase – mainly in areas already susceptible Many tropical crops are already near threshold temperatures Extreme hydro- meteorological events will become more frequent for most land areas over the longer term Source: ODI. A rough guide to climate change and agriculture, March 2007

10. But it is clear -the developing world is worst affected in the long run Summary Estimates for Impact of Global Warming on World Agricultural Output Potential by 2080s(percent) Without carbon With carbon fertilization fertilization World -16 -3 Rich countries -6 8 Developing countries -21 -9 Median -26 -15 Africa -28 -17 Asia -19 -7 Middle East- North Africa -21 -9 Latin America -24 -13 Mexico -35 -26 Based on Cline, William, Global Warming and Agriculture: Impact Estimates by Country, Table 7.1.

11. However there is great uncertainty in projections Results, selected countries (percent change in agricultural productivity) Ricardian Crop Model Weighted Avg w/oCF w/CF Argentina -4 -18.1 -11.1 2.2 Brazil -5.1 -28.7 -16.9 -4.4 US 4.7 -16.5 -5.9 8.0 SW plains -11.1 -59.0 -35.1 -25.0 India -49.2 -27.0 -38.1 -28.8 China 3.8 -12.6 -7.2 6.8 S. Central -18.8 -12.6 -14.6 -1.8 Based on Cline, William, Global Warming and Agriculture: Impact Estimates by Country, Table 7.1.

12. Including price Ref: FAO. Adaptation to Climate Change in Agriculture, Forestry and Fisheries, 2007

13. And models are incomplete Factors not allowed for: Positive: Technology improvement (e.g. flood tolerant rice, drought tolerant wheat and maize) Changed income mixes Negative: Increased weather volatility Insect infestation Loss of water table and glacial water (short term increase for the latter) Loss of species diversity ?: Feedback loops (e.g. from land use change) Scale effects – climate model v. farm systems

14. C: A comprehensive value chain approach is required

15. Value chain management can reduce riskCase Study of Maize Procurement Centers – AP/ India • Federated Institutions with own savings and credit products • Procurement Centers • Physical infrastructure (i.e., small rented or own building, weighing instruments, moisture meters, and sieving equipment) • Trading Platform (to be networked with Virtual Private Network). • Developing good quality network of service providers with the following skills: • Market Based Information: Micro planning for procurement & Market Research Data • Quality Control: Moisture control, grading • Financial Management: Accounting & Book keeping • Logistics • Enterprise Management • Labor Management & Conflict Resolution

16. Procurement Centers in AP have raised farmer incomes • 1610Procurement centers • 81Commodities • $100 Millions in turnover • Over 200,000Paraprofessionals: Barefoot Botanists, Book keepers, Quality Controllers • Partners include: • AP Markfed (Largest Cooperative in Agricultural Products in the State) • (ii) ITC Ltd (Agribusiness Multinational) • (iii) Olam International (Largest Exporter of Cashews in the World) • Agrotech Foods Ltd. (Multinational with dominant share in the refined oil segment) • Products include: Turmeric, Lac, Maize, Neem, Red Gram, Sunflower Seeds, Cashew, Groundnut, Organic Cotton Source: Rao.K.P et al. South Asia Rural Livelihoods Series 1, Notes 2 and 4, World Bank

17. Procurement Center Franchise Model For small and marginal farmers: • Enhanced Price (+10%) • Weighing Benefits (+5-10%) • Saving on Driage Loss (50% less than middle men) • Saving on transportation (+ 15 – 20%) • Elimination of price uncertainty • Saving on one day wage labor • Cash Payment Source: Rao.K.P et al. South Asia Rural Livelihoods Series 1, Notes 2 and 4, World Bank

18. Savings and credit have a role in inter-temporal consumption smoothing – but not for relatively infrequent severe systemic events Informal credit – breaks down under systemic risk and societal change Microfinance – if available – but not useful in extreme situations Savings – if safe mechanisms are available – but again not able to deal with extreme situations

19. D: Insurance plays a key role for production risk – but it’s a case of horses for courses

20. Key Assumption for what follows Price is set by international markets, or otherwise independent of domestic yield Limited direct public interventions in markets (e.g. central purchasing boards). Reasonably efficient value chain – storage, transport, pricing methods etc Limited misaligned incentives (e,g, corn ethanol subsidies) No systemic global weather correlations

21. Insurance seen as an important mechanism by Rio, Kyoto and IPCC 4th AR Source: IPCC 4, Synthesis Report

22. Role of Insurance –Hazell et al – 1986 seminal book Increase agricultural efficiency by reducing ex ante risk Smooth income ex post Mechanism for social transfers – political rather than effective approach – direct transfers work better.

23. Does it makes sense – rational economic model Overall benefit – OAD Ultimate benefit to farmer – P1DO – P0AO Determinants Elasticity of demand Net price of insurance Source; Hazell, P et, al. Crop Insurance for Agricultural Development, John Hopkins, 1986, Ch 7 (Siamwalla and Valdes)

24. It did not work with traditional indemnity insurance Subsidy necessary for all except hail, fire and single crops (typically >50% total cost) Moral hazard – farmer harvests insurance rather than crops Information asymmetry – farmer knows more about risk than insurer Administration – crop inspection, loss assessment and opportunity cost of time to payment of claim Political capture

25. And pricing (expected loss plus expense loading plus cost of capital) can be high for other reasons Trigger is hit too frequently – inefficient use of insurance – credit and savings, (direct donor support for sovereigns) may be better instruments High losses and uncertainty for infrequent events pushes up capital charge and cost of capital The agriculture involved is non viable – a policy issue not a market issue

26. In addition willingness to pay shows complex patterns Morocco (cereal) – willing to pay 12% to 20% above expected loss for contract – but only for lower triggers in low variability areas – MCarthy, N. IFPRI using WB study as input Vietnam (litchi) – farmers overestimate area yields, wealthier farmers more likely to participate – education important – Vandeveer, M. USDA, published in Agricultural Economics, 2001

27. However, subsidies are hard to justify in a welfare economics framework Economically inefficient per indifference curves May be justified: To build institutions and infrastructure if free rider problem exists During initial learning curves of suppliers and consumers To support new technology – but questionable

28. An ideal Cost/ price nearer to expected loss Simple objective claims triggers linked to actual loss - reduced or no in field crop and loss assessments Simple pay out formulae Rapid payout of claims Correct risk level signaling No direct long term subsidies

29. Initial WB studies (early 2000s) : rural bank exposures to drought, emerging degree day market in the US, seed funds from WB President and FSE VP Mexico: For about 40% of the planted area, rainfall contracts could reduce relative yield risk between 9% and 29%. More specifically, in Durango the risk reduction in yields is 23%, in Jalisco 28.6%, in Tamaulipas 9% and in Zacatecas 29%. Morocco:

30. Two possible approaches the WB now supports

31. And the response depends on the client and the hazard

32. Example of parametric payoff schedule Reference: Skees, J. The Potential of Weather Insurance for Spurring a Green Revolution in Africa

33. Other issues Links to credit Appropriate insurance infrastructure – involve the local industry or separate fund or combination (PPP)? Appropriate legal infrastructure – status of parametric covers – insurance or derivatives? Education of farmers/ herders – quality of outreach services? Payment in non cash/ non bank account societies? Role of government targets/ suasion (India and South Africa)

34. Some additional questions will need to be asked in the longer term CC scenario How valid will past experience be for pricing, benefit and trigger design? Can these concerns be overcome by actuarial techniques and physical modeling – e.g credibility methods, agronomic models etc

35. E: A taxonomy of initiatives

37. Some lessons learned over the last decade Each situation is different – there are no silver bullets – do a decent diagnostic first Integrate into the full value chain of interventions Infrastructure development will often be required in advance Educating the consumer will take time – but long term subsidies are usually welfare reducing The design will usually need tweaking with experience – these projects often require above average levels of supervision and can cover many years.

38. The Donors are now engaged • EC - €25 million – IFC administered TF for ACP countries • Gates – Initial $1 million then $25 million - WFP