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An exploration of commodity income stabilization options for coffee farmers - page 20 / 47

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exposure. Farmers may sell their berries in an unmilled state, or they may mill it in a cooperative coffee mill or even toll-mill it with a private miller. They may sell all of their coffee once their berries have been dried or milled, or they may stock a significant portion for later sales (most farmers store at least some of their coffee). In some cases, farmers give up ownership and all upside price potential directly after the harvest; in others, they sell their crop but keep the opportunity to benefit from price increases; in yet others they (generally through a cooperative) keep control over marketing and pricing until or even after the sale of the processed product. Possibly with their cooperative as a buyer, some farmers sell at prices determined in local markets (which, as discussed in the previous section, tend to follow world markets), others can benefit from minimum prices and/or above-market prices paid under special trading arrangements (fair trade, organic coffee, etc.).

Conceptually, there are two special aspects of price risk exposure in this post-harvest phase. First, in some cases, farmers give up all upside price potential; in others they keep it—which is equivalent to the financial market’s call option. Given the nature of coffee price movements (occasional extreme price peaks) such call options can be very valuable for farmers. Second, organizational relationships become complex—in particular, when some risks are explicitly borne by a farmers’ cooperative, how can this cooperative fairly distribute such risk between itself, as an independent entity, and its member farmers? Socio-political and economic factors (competitive pressures from private traders) have an important impact on how cooperatives deal with risk—Box 2 describes this in some more detail.

Risks hit the poor hardest.15 It is worth noting that in all areas of risk exposure, farmers’ response to risk depends on their ability to carry risk. This, to a large extent, is a function of their overall wealth, and the poorest farmers therefore tend to be the most risk averse. To the extent that traditional risk mitigation tools lead to reduced average incomes,16 then, exposure to risk is likely to perpetuate and reinforce rural income inequalities. “Avoiding high-risk investment choices can lock poor households into low-risk, low-return production patterns, thus keeping them in a classic poverty trap.”17 One study of Ugandan coffee farmers concludes that “coffee farmers who believe coffee to be more risky, are more risk loving, and better able to take on risky activities devote more resources to coffee production. For wealthier farmers, risk preferences do not affect crop production choices to the same extent. Estimates suggest poor, risk-averse farmers may be losing a potential of 7 per cent of annual crop income as a result of being less likely to produce coffee.” 18

15 “When a poor household does not have an effective strategy to insure itself against risks, this can send it into a catastrophic downward spiral to destitution. This causes the severity of poverty to worsen as already-poor households sink deeper into poverty and increases the prevalence of poverty as previously non-poor households fall below the poverty line. Shocks can also have non-catastrophic consequences for poor households that nevertheless cause them to suffer very high and often irreversible income losses.” Human Development Group, Africa Region, Dynamic risk management and the poor, The World Bank, July 2000.

16 “The costs of informal insurance against risk can be very high for poorer households… Households in risk- prone semi-arid areas of India may have had to sacrifice as much as 25 per cent of average incomes to reduce exposure to shocks.” (idem). “Traditional systems might persist well after they are the best means for addressing problems… In these cases, risk-mitigating mechanisms that are part of a household’s own poverty alleviation strategy can turn out to be part of the problem… There is a role for policy in fostering movement towards situations where poor households use more flexible mechanisms to address risk.” (J.J. Morduch, “Issues on risk and poverty,” mimeo, Stiglitz Summer Research Workshop on Poverty, The World Bank, Washington D.C., July 6–8, 1999).

17 18 idem Ruth Vargas Hill, The role of risk in shaping production decisions: an application to coffee farmers in Uganda, University of Oxford, mimeo, 2005.

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