Working Paper: NBER ID: w22276
Authors: Treb Allen; David Atkin
Abstract: Trade liberalization changes the volatility of returns by reducing the negative correlation between local prices and productivity shocks. In this paper, we explore these second moment effects of trade. Using forty years of agricultural micro-data from India, we show that falling trade costs due to expansions of the Indian highway network reduced the responsiveness of local prices to local rainfall but increased the responsiveness of local prices to prices elsewhere. In response, farmers shifted their production toward crops with less volatile yields, especially so for those with poor access to risk mitigating technologies such as banks. We then characterize how volatility affects farmer's crop allocation using a portfolio choice framework where returns are determined in general equilibrium by a many-location, many-good Ricardian trade model with flexible trade costs. Finally, we structurally estimate the model—recovering farmers' risk-return preferences from the gradient of the mean-variance frontier at their observed crop choices—to quantify the second moment effects of trade. We find that first moment gains from specialization dominate second moment effects on average and that improvements in risk-mitigating technologies would encourage farmers to take advantage of higher-risk higher-return allocations, with the strength of these effects hinging on whether the riskiest crops are also the comparative advantage ones.
Keywords: Trade Liberalization; Volatility; Agricultural Economics; Risk Mitigation
JEL Codes: F1; G11; O13; O18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Trade costs (F19) | Farmers' crop allocation towards less volatile yields (Q12) |
| Trade costs (F19) | Farmers' land allocation based on risk-return preferences (Q15) |
| Trade liberalization (F13) | Responsiveness of local prices to local rainfall (Q11) |
| Trade liberalization (F13) | Responsiveness of local prices to prices elsewhere (F16) |
| Trade benefits (F14) | Farmers' income despite increased volatility (Q11) |
| Access to risk-mitigating technologies (O33) | Farmers' crop allocation towards higher-risk, higher-return crops (Q12) |