Supply response to countercyclical payments and base acre updating under uncertainty: an experimental study.

Third, the possible market effects have ramifications for government spending and trade. If producers switch from nonprogram to program crops so the supply of each program crop increases, program crop prices will fall (holding demand steady). As each program crop price decreases, the chance increases each individual program crop will qualify for CCPs, which increases government expenditures. Another issue is whether CCPs would be classified as "blue box" or production and trade distorting "amber box" domestic subsidies under World Trade Organization rules. Both spending categories are subject to limits under recent (October 2005) U.S. negotiating proposals and including CCPs in either category increases the possibility of exceeding WTO spending limits. (28)

Westcott (2005) points out that production distortion from CCPs may be "limited" in naturally occurring markets due to several factors. For example, farmers have other risk management tools at their disposal; large and less risk-averse farms tend to dominate production of program crops; and other programs such as marketing loan provisions already offer price protection. These factors underscore the difficulty of separating the effects of CCPs from other influences in observed annual production data, a difficulty reduced when using experimental methods.

As noted by Roth (1995), experimental methods can provide rapid feedback to policy makers about issues that are not easily teased out with observed data. Roe and Randall (2002) further suggest that "the field of agricultural risk analysis could benefit ... from continued research using experimental methods" in policy analysis. Our design isolated the CCP incentives under risk. Result 1 supports the idea that CCPs can be production distorting, as participants altered production choice toward planting more in the base crop. This result is supported by Anton and Le Mouel (2004) who find the risk reducing incentives of CCPs are significant as revealed by the estimated risk premia.

Our design did not address two features of the 2002 Act, which could affect the interpretation of our results. First, there are no adjustments made in our bonuses for the fact that direct and CCPs are made only on a percentage (85%) of base acres. If these adjustments were incorporated, the lump-sum bonuses would have been lower, implying our results could overstate the effects of CCPs. Second, we excluded the marketing loan program to focus on the basic CCP structure--target price, market price, and direct rate. Adding the marketing loan program into our design would temper the basic effects of CCPs by providing an additional price support mechanism.

Discussion of H2 Results

The impact of the base acre updating clause depends on expected benefits from future programs, which in turn depend on the continuation of such programs (Westcott, Young, and Price 2002). By introducing policy uncertainty (with the possibility of mandatory updating) along with CCPs, we examine how compounding these two risks affect production choices compared to our baseline, which we summarize as Result 2.

RESULT 2. We find evidence in favor of hypothesis H2: A CCP style-subsidy program and policy uncertainty (with the possibility of mandatory base acreage updating) induced subjects to allocate more to the base option.

Support. We reject at the 5% significance level the null to hypothesis H2 that people are equally responsive to price signals between crop (token) allocation choices in the Policy risk case and the Baseline case. The coefficient suggests that there is an average increase of 7.92% toward investment in the base crop option in the Policy risk case compared to the Baseline case, holding all else equal. Introducing a CCP along with policy uncertainty, including mandatory updating, shifted crop allocation toward the base crop. The implications for the agricultural economy are similar to those discussed for Result 1.

The Policy risk case included both price and policy risk in a simplified setting, which created one key caveat. In our design, if the update option was realized, our players had to update (no choice to opt out). In reality, producers had the option not to update base acres in the 2002 Farm Act, and it is possible that the same could occur under future legislation. Most producers would likely use this "opt out" feature if it were added to our design, which implies less incentive to plant the base crop since the current design starts each participant with all base acres. Unless the player allocated all tokens to Blue (base), updating base would reduce per round earnings. If players never updated, the results should be indistinguishable from the CCP case.

Discussion of H3 Results

Another policy question is whether producers changed cropping strategies between the CCP and Policy risk case. Did mandatory updating cause them to ignore market signals and "plant to maintain base" in an attempt to maximize available subsidies? Result 3 suggests producers had a limited reaction to this policy risk.

RESULT 3. We find insufficient evidence to support hypothesis H3: The coefficients of the CCP and Policy Risk case variables are not statistically different from each other.

Support. We cannot reject at the 5% significance level the null hypothesis that the effects of the CCP case and Policy risk case are the same. The Wald test indicates that there is no statistical difference between the CCP case and Policy risk case coefficients (p-value 0.20). The lack of statistical evidence makes it challenging to disentangle the effects of policy uncertainty. Did participants not consider the change between the CCP case and the Policy risk case, or did the opposing effects of our policy uncertainty cancel out? Since the coefficients indicate the total effect with CCPs and policy uncertainty is probably at least as large as with just the CCP, it is possible the incentive to plant the base (Blue) crop is stronger with mandatory updating despite the countervailing incentive created by the chance of policy elimination. This result suggests that participants were "planting to maintain base" (to secure future program payments). These participants disregarded current market signals to maintain or enhance program payments.

These results are similar to findings in Lusk and Coble (2003). Their experimental study had players make decisions over choices similar to our risk preference X-test, in which some of them faced an additional background mean-zero lottery. They tested for levels of risk aversion and found players who faced background risk were slightly more risk averse. Our results are adding policy risk on top of price risk induced incrementally more allocations to the base crop. Again this is a risk minimizing choice.

Conclusion

This study examined the production effects of CCPs and base acre updating under price and policy uncertainty in an experimental market. The experimental design allowed us to isolate how CCPs affect the mix of base and nonbase crops. The evidence suggests CCPs influence crop allocation decisions in the lab--the average player allocated more acres toward the base crop option relative to the absence of CCPs. The results were similar after adding policy uncertainty with a possibility of mandatory base updating. Our findings do not rule out nontrivial impacts to producers' planting choices, income, crop markets, and allocative efficiency.

Several extensions to our design could be considered. Mean-preserving spreads of prices and probabilities would test whether CCPs would have more impact on planting decisions. Understanding the extent of this impact would further clarify the key incentives affecting cropping decisions with available program payments. Second, one could examine how subjects react to more downside "hits" and how long it takes to recover from these shocks. Changing the Policy risk case probabilities could provide more insight into whether "planting to maintain base" occurs in the lab. A third extension is to allow for variable base acres and optional updating. Fourth, bankruptcy could be added, which would increase incentives to use a maximin strategy. Finally, marketing loans and other risk-reduction options can be added to test the robustness of our results to a broader range of outside options.

[Received November 2005; accepted November 2006.]

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