Mitigating farm risk: Finance can be more helpful than agri economists

The financial markets have more-or-less stamped out uncertainty, and that can offer a lesson for reducing agricultural risk

A few days ago, a very good friend, whom I had known for 52 years, passed away. He was an agricultural economist by training, academic by profession, and policymaker by preference. He had been in several important positions in the government.

Every now and then, I would rib him about his chosen branch of economics. The question I would ask-which wasn't a fair one-was this: why don't agricultural economists make any difference to Indian agriculture, whose problem has remained the same for a thousand years, namely, high and volatile risk?

He would answer it in his customary, gentle way. But his answers were rooted more in the political economy than in the area of technical risk management. He recognised risk, obviously, but for him, state intervention was the way to mitigate it.

The only ones who have come close to a satisfactory answer to risk in agriculture are the finance boys, perhaps because they study risk very differently. So, in my possibly uninformed view, it is them that the government should consult rather than mainstream agricultural economists. It might get better results.

If you think about it, finance and agriculture have a lot in common. The outer trappings of each occupation hide these similarities, but if you peel those away, the basic similarities become very clear.

Risk exists because of uncertainty, but while risk can be managed, uncertainty, by its very definition, cannot. For example, there is a risk when you drive, and you can manage that risk by driving slowly and following all the rules, but what do you do if someone suddenly runs across your car? That's what uncertainty is, and it can't be managed.

In agriculture, risk and uncertainty exist largely because of the weather, now called climate. That is, for reasons extraneous to farming. If the Pacific Ocean heats up (or doesn't), what can a farmer do about it?

It is the same thing with finance. Outcomes can turn adverse for totally extraneous reasons, like Russia invading Ukraine or China burning more coal because it has a drought and its hydroelectric production is zero now.

The short point is about the exogeneity of risk caused by uncertainty. But whereas in finance this is managed very well, in agriculture it is not. We need to find out why. One way would be for agricultural economists to study the basics of financial risk management in great detail.

Farmers face two types of risk mainly: output risk because of the weather and price risk because the output can be very high or very low but rarely at the exact level where price risk is zero or close to zero. In other words, everything depends on what happens to output.

This is true of finance as well, except it's not called output there. There are different names for it, but the essential characteristic is the same: more is better, but the risk is also higher.

With tremendous regulatory support, which is not the same as state intervention, the financial markets have more-or-less stamped out uncertainty. It's there, of course, but dampened down hugely and with means to tackle it.

Agriculture, on the other hand, despite its importance, has had practically no mechanisms to mitigate the effects of uncertainty. Risk, yes, up to a point. But uncertainty, not really. The best way forward is futures and forward markets. My economist friend had chaired a committee on it. But sadly, he didn't think much of the idea.

Still, it's never too late — and here's a hint. The finance secretary and the chief economic adviser both have PhDs in finance. They have also co-authored books on finance. They can take the lead.