On- and Off-Farm Diversification in Farm Households

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					                    On- and Off-Farm Diversification in Farm Households

                            Christoph Weiss and Kevin McNamara

In contrast to large corporate firms in the non-farm economy, where the wide dispersion of
ownership helps to spread business risk over numerous stockholders, the smaller family farms
in agriculture have little capacity for this kind of risk reduction given that a large share of the
family's and the farm operator's wealth as well as their labour capacity is allocated to their
own (farm) business. It is well known that on-farm product diversification (diversification of
farm production activities) can be an efficient mechanism for dealing with risk by stabilising
expected returns in an uncertain environment.

Diversification of production on the farm (on-farm diversification) however, is only one way
to deal with income fluctuations and risk in agriculture. Another important means to reduce
variability of household income and risk is off-farm employment participation (off-farm
diversification). The last two centuries have seen a considerable volume of empirical research
on the off-farm employment participation of farmers. However, limited attention has been
devoted to the role of farm income in total farm household income variability.

The present paper brings together the two strands of literature by analysing the
interrelationship between on-farm and off-farm diversification econometrically. The empirical
approach in the paper utilises a panel of 39,235 farm households for three years 1980, 1985
and 1990.

Estimation results from a simultaneous bivariate probit model suggests on-farm and off-farm
diversification decisions are closely related. The degree of diversification was significantly
lower for farms where the farm operator was working off-the farm. In addition we find the
degree of on-farm diversification, as well as the probability of off-farm diversification to be
significantly related to farm characteristics (farm size and past farm growth), operator
characteristics (age and schooling), and regional economic characteristics.

These results have important policy implications. Whereas government market interventions
have caused domestic prices to vary substantially less than international ones in the past,
farmers (as well as those working on policies concerned with their welfare) are forced to
consider the implications of larger fluctuations in commodity prices as domestic prices start
following international price signals more closely in the future. Our results imply that these
changes will result in more off-farm diversification and/or more on-farm diversification.
Which of the two strategies actually is chosen by the farm operators will not only have
important consequences for the performance of their individual farm but will also influence
the structure of the farm sector in the future.