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A Stochastic Dynamic Programming Model Of Direct Subsidy Payments And Agricultural Investment

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  • Vercammen, James
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    Abstract

    A stochastic dynamic programming model is used to compare the farmland investment impact of a fully decoupled direct payment and a standard price subsidy. The direct payment induces the farmer to invest because it lowers the farm's debt to asset ratio, which in turn reduces the probability of bankruptcy. The value of the real option to defer the investment decision is lower with a lower risk of bankruptcy, and thus the direct payment results in a higher probability of immediate investment. Simulation results demonstrate that for a farm facing moderate revenue and land price variability, the impact of a decoupled direct payment on farm investment is nearly as large as the investment impact of an equal-sized price subsidy. These results suggest that direct payments, such as those associated with U.S. production flexibility contracts, should be carefully scrutinized in on-going multilateral trade negotiations.

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    Bibliographic Info

    Paper provided by University of British Columbia, Food and Resource Economics in its series Working Papers with number 15847.

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    Date of creation: 2003
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    Handle: RePEc:ags:ubcwps:15847

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    Web page: http://www.landfood.ubc.ca/fre/
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    Related research

    Keywords: Agricultural and Food Policy; Agricultural Finance; International Development;

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    1. Benjamin, Dwayne, 1992. "Household Composition, Labor Markets, and Labor Demand: Testing for Separation in Agricultural Household Models," Econometrica, Econometric Society, vol. 60(2), pages 287-322, March.
    2. Hennessy, David A., 1998. "The Production Effects of Agricultural Income Support Policies Under Uncertainty," Staff General Research Papers 1207, Iowa State University, Department of Economics.
    3. Vercammen, James, 2000. "Irreversible investment under uncertainty and the threat of bankruptcy," Economics Letters, Elsevier, vol. 66(3), pages 319-325, March.
    4. Mary E. Burfisher & Sherman Robinson & Karen Thierfelder, 2000. "North American Farm Programs and the WTO," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 82(3), pages 768-774.
    5. Richard Holt, 2004. "Investment and Dividends under Irreversibility and Financial Constraints," ESE Discussion Papers 55, Edinburgh School of Economics, University of Edinburgh.
    6. Falk, Barry L., 1991. "Formally Testing the Present Value Model of Farmland Prices," Staff General Research Papers 11093, Iowa State University, Department of Economics.
    7. Barry Falk & Bong-Soo Lee, 1998. "Fads versus Fundamentals in Farmland Prices," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 80(4), pages 696-707.
    8. Oliver Mahul, 2000. "The Output Decision of a Risk-Neutral Producer under Risk of Liquidation," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 82(1), pages 49-58.
    9. Milne, Alistair & Robertson, Donald, 1996. "Firm behaviour under the threat of liquidation," Journal of Economic Dynamics and Control, Elsevier, vol. 20(8), pages 1427-1449, August.
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    Cited by:
    1. Heikkinen, Tiina & Pietola, Kyosti, 2006. "Investment and the Dynamic Cost of Income Uncertainty: the Case of Diminishing Expectations in Agriculture," Discussion Papers 11868, MTT Agrifood Research Finland.
    2. Baffes, John & De Gorter, Harry, 2005. "Disciplining agricultural support through decoupling," Policy Research Working Paper Series 3533, The World Bank.

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