1. Consumption Preferences, Risk and Production Choices – the Case of Ethiopian Farm Households Alemayehu Seyoum Taffesse

2. Objectives  Explore the impact of yield and price risk on Ethiopian farm household’s welfare in the context of incomplete markets;  Assess the effect of the consumption preferences of Ethiopian farm households on their crop portfolio.

3. Key Observations  Yield risks facing Ethiopian farm households are considerable; CropCV of Yield - Overall SD of Yield Shocks Idiosyncratic Barley1.040.70 Maize0.850.79 Sorghum3.450.90 Teff0.830.75 Wheat0.850.65 Pulses0.910.60

4.  Price risks are also considerable; Key Observations CropCV – Monthly Prices CV – Monthly Prices regional quartiles Barley0.151stQ = 0.12 Maize0.182ndQ = 0.15 Sorghum0.183rdQ = 0.18 Teff0.15 Wheat0.14 Pulses0.16

5.  Output, Input, Credit, and insurance markets are either non-existent or highly incomplete and fragmented (even grain markets are not well integrated);  Consequently, the impact of yield and price risks on current and future welfare is huge; Key Observations

6.  Households largely rely on a variety of household-level and collective ways of their own to cope with risk. including:  diversification of the portfolio of income generating activities,  preference for self-sufficiency (primarily food),  flexibility in resource use,  precautionary saving,  intergenerational co-residence, and  mutual insurance arrangements

7. Key Observations  The literature on yield risk in Ethiopia and its impacts is substantial;  Little work on consumption price risk (volatility of prices of consumer goods including those they can themselves produce);  This presentation focuses on two issues:  The impact of preferences and endowments on production choices (non-separability)  the impact of consumption price risk on farmers’ crop choice.

8. Methodology  A non-separable agricultural household model under yield and price risk is adopted (an inter- temporal asset portfolio choice model)  Land allocation and consumption levels are the choice variable  Household survey data (Economics at AAU/CSAE/IFPRI) and time series data (CSA) are used for estimating relevant parameters.

9. Preferences, Endowments, and Production  Complete markets assumption implies that preferences and endowments do not affect production choices (separability);  A test: reduced-form model  Regress acreage shares on determinants of crop yield, consumption preferences, and endowments (risk bearing capacity);  Test the joint significance of preference and endowment variables – rejection means incomplete markets.

10. Preferences, Endowments, and Production  Dependent variables: acreage shares of barley, maize, pulses, sorghum, teff, and wheat  Explanatory variables:  Productivity – no. of adults per hectare, years of schooling of household head, number of oxen, fertilizer application, fertility and slope of plots, round and village dummies;  Preferences – dependency ratio;  Endowments – non-crop income, no. of shoats, total acreage.

11. Preferences, Endowments, and Production Data :  Five rounds of the Ethiopian Rural Household Survey of the Economics Department of AAU/CSAE/IFPRI;  Sample restricted to predominantly cereal producing villages Estimation:  Restricted least squares for individual acreage equations; and  SURE for the six equations jointly.

12. Preferences, Endowments, and Production Wald test – SURE equations: Chi-squared[ 6] = 22.5736 *** Wald Test – individual acreage equations: F [1, 2950]

13. Impact of Consumption Preferences on Crop Portfolio

14. Estimates

15. Results – Impact of Consumption Shares Relative Risk Aversion  l s /  w s = Derivative of l s wrt w s (l s /w s )(  l s /  w s ) = Elasticity of l s wrt w s  1 (=1.33) 0.0480.047  2 (=2) 0.1080.105

16. Implications  Poverty traps – risk can perpetuate poverty  Lack of specialization  low productivity  low income;  Low-return staple production  low income  Agricultural transformation  Preference for self sufficiency can induce slower adoption and innovation;

17. Implications  Policy  Exclusive focus on on production-side factors such as yield risk may not be effective;  Consumption-side interventions can have considerable impact;  appropriate price stabilization interventions;  crop sales directly to farm households through outlets run by non-governmental organizations (NGOs) or government agencies;  provision of consumption credit to farm households by governmental and non-governmental agencies;  Research and development – innovations in storage