Trade Adjustment Costs in Developing Countries: - World Bank ...

92Olivier Cadot, Laure Dutoit and Marcelo OlarreagaThe appropriate estimation technique depends on two aspects of the problem.The first is whether the switch point between regime 1 and regime 2 is observedor not. As we noted earlier, how much a farmer sells is a continuum and it maybe hazardous to set an arbitrary switch point. The econometrician may insteadwant to ‘let the data speak’ and determine the switch point simultaneously withthe model’s other parameters. The second aspect is the scope for reverse causality,which is of course unavoidable, as income differentials should be the maindriver of selection. Together, these two features of the problem (unknown switchpoint and endogenous selection) call for a particular ML estimation techniqueinspired of Heckman’s selection model. 1 Consistent estimation of the parametersin (1) and (2) makes it possible to calculate an individual’s predicted income inboth regimes, including the unobserved one, and hence to estimate the incomedifferential conditional on individual covariates. Applying this technique to farmerssurveyed in Madagascar’s Enquête Permanente des Ménages, Cadot et al.(2006) found a switch-point at zero market sales, which defined subsistence farmersas those that were in true autarky (10 per cent of the sample), and an averageincome loss of 43 per cent for those farmers, conditional on covariates andcontrolling for endogenous selection.Thus, although parametric evidence is fragmentary, it is suggestive of very substantialincome differentials after controlling for individual effects, begging thequestion, what prevents subsistence farmers from exploiting profitable marketopportunities? Clearly, if subsistence farmers forsake substantial income by notgoing to the market, or not producing what the market would buy, they mustface formidable barriers to ‘going commercial’. What are those barriers?3. BARRIERS TO EXIT3.1 RiskIn the absence of properly functioning insurance mechanisms, food self-sufficiencycan be seen by farmers as insurance if cash crops are perceived as inherentlyriskier than food crops. This conjecture is perhaps the oldest in the analysisof subsistence agriculture.When income-generating production is risky, farmers can, using the terminologyof Alderman and Paxson (1992), adopt either (or both) risk-managementstrategies—for example, diversifying crops whenever possible to reduce incomerisk—or risk-coping ones—for example, saving in order to reduce the transmissionof income risk to consumption. Risk-management strategies have been extensivelystudied in the literature: see for example, Shahabudin, (1982), Binswangerand Sillers (1983), and Fafchamps (1992) to name but a few. Unsurprisingly, arunning theme of that literature is that price uncertainty on cash-crop marketsraises the weight of food crops in the optimal allocation of land, relative to whata comparison of returns would suggest.1 Dutoit (2006) provides a through survey of switching-regression techniques, together with Stataapplications.