New research finds that investment levels by small-scale African farmers may be subdued because farmers dislike others in their community helping them when investments fail. The study by Dr Ben D''Exelle and Dr Arjan Verschoor, both at the University of East Anglia, analyses poor farmers'' risk-taking behaviour in rural villages in Eastern Uganda, making use of experimental methods.
The key findings of the research, which is published in the May 2015 issue of the Economic Journal, are that:
· Solidarity mechanisms in rural villages put pressure on successful entrepreneurs to share profits made from investments with others, while farmers whose investments fail receive support to compensate for the resulting losses.
· Comparing the profit- and loss-sharing aspects of this solidarity system, loss-sharing exerts the strongest influence on investment behaviour. As a direct result of loss-sharing (which the experimental design isolates), investment levels are substantially lower.
These results contradict commonly held suppositions about the effects of solidarity systems in rural Africa on investment and growth.
Dr D''Exelle says:
''The commonly held notion that profit-sharing dampens investment incentives is contradicted by our research. Investment levels are not lower when profits can be shared. Indeed, when profits can be shared and one is paired with friends, investment levels are actually higher.''
''Moreover, it is loss-sharing that dampens investment, as investors are wary of being helped by others when their investment fails.''
''We think that a combination of directed altruism and expected reciprocity is most plausible to explain these results, but future research is needed to identify the exact drivers. Given the urgent need for higher investment levels to combat poverty in sub-Saharan Africa, this is an important avenue of future research.''
Does the solidarity system in rural villages discourage investment behaviour? What specific influence do loss-sharing and profit-sharing exert on investment propensities? Do the loss-sharing effects outweigh the profit-sharing effects? And do the social ties among farmers matter for the strength of the effects?
These are some of the important questions addressed by this study. Previous research on informal risk-sharing in sub-Saharan Africa suggests that sharing obligations dampen incentives to invest, as profits need to be shared with others. On the other hand, there is a potential positive effect of risk-sharing on investment too, through the sharing of losses.
There are indeed two sides of existing solidarity systems in rural villages. Investment risks are pooled so that both profits and losses tend to be shared. As profit- and loss-sharing may have different effects on investment propensities and these effects are at work simultaneously, both effects need to be disentangled, which is the contribution of this study.
To do so, the researchers use an experiment in which participants decide how much to invest in a risky activity. Depending on the treatment, profits that may result from the investment can be shared with a paired person, and/or the paired person can compensate the investor for losses that the investment may give rise to.
''Investment Behaviour, Risk Sharing and Social Distance'' by Ben D''Exelle and Arjan Verschoor is published in the May 2015 issue of the Economic Journal. Ben D''Exelle and Arjan Verschoor are at the University of East Anglia.