The Economics of Crop Insurance and Disaster Aid.

• Author: Hammond, Claire Holton

This book is a nifty example of the insights that careful economic analysis can bring to public policy debate and reform. Barry Goodwin and Vincent Smith, agricultural economists from North Carolina State University and Montana State University respectively, do an excellent job presenting in clear and straightforward fashion the economic history and implications of the federal crop insurance and disaster aid program. This program cost the federal government more than $25 billion in subsidies and payments in the period 1985-1993 alone.

Goodwin and Smith begin their analysis with a simple question: What is the purpose of federal multiple-peril crop insurance (including disaster aid, which they correctly describe as a form of premium-free crop insurance)? They report several possible answers: to rectify market failure stemming from the inability of the private market to deal efficiently with problems of moral hazard and adverse selection; to enhance equity by transferring income from well-off taxpayers to distressed and less well-off farmers; or, finally to transfer income to farmers as a way of garnering their political support. Goodwin and Smith systematically review the evidence for each of these arguments.

In Chapters Two and Three they describe the current crop insurance and disaster payment program and chart its evolution from its inception in 1938. The legislative history of the 1938 Crop Insurance Act reveals a concern on the part of the legislators of that time, not to address any market failures of the private crop insurance market, but to relieve widespread hardships caused by recent, severe droughts. From the beginning the program has been plagued by problems of moral hazard and adverse selection. Moral hazard problems result when farmers adopt poor farming practices because they are insured. Adverse selection problems result when low-risk farmers are charged too high premiums and therefore choose not to participate, leaving a higher proportion of high-risk farmers in the insurance pool and causing a upward spiral in premiums if actuarial soundness is to be maintained. These twin problems have doomed federal crop insurance to high losses and low participation rates. This has not gone unnoticed by Congress which regularly tries to reduce losses and increase participation rates with legislative tinkering (the most recent example is the 1994 Crop Insurance Reform Act).

Goodwin and Smith describe four distinct phases of legislative...