Financial Engineering Key to Sustainable Development in Africa?
After tackling the issue of aquaculture a few weeks ago, Columbia University's Jeffrey Sachs is back to weigh in on one of his latest eco-initiatives: unleashing a green revolution in Africa by using the powers of risk management. Central to his essay is the argument that since life in poor, developing African nations is often fraught with considerable risk (households lacking health insurance, diversified income revenues and crop failure insurance, amongst others), farmers need to have the proper financial tools at their disposal to improve their odds and, hopefully, lives.
A simple disturbance, such as a temporary drought or disease (conditions that will likely worsen and become more frequent with the gradual onset of global warming), could be enough to knock an African household off its feet and into debt, or worse. Therefore, Sachs explains that proper risk management is critical to the farmers' well-being and their financial viability since it increases their creditworthiness and thus allows them to make investments in high-yield activities such as higher value-added farming (using fertilizer to plant their crops). Engaging in these activities greatly diminishes the likelihood that a farmer will fall into poverty. Citing the success of other financial schemes like micro-finance in boosting the lives of destitute farmers, Sachs raises the concept of micro-insurance as an instrument to further the progress already made. Micro-insurance as he envisions it, unlike traditional crop insurance, would have the effect of improving the fortunes of both the farmers and the companies involved and carry little risk.
According to Sachs, this is because a traditional policy, which makes payments on the basis of measured crop losses incurred from specific hazards (like pests, temperature fluctuations, drought), could not work under the current circumstances. The high costs of marketing and assessing losses, as well as the farmers' sometimes questionable actions and risky dispositions, render such policies unpalatable to the insurance companies.
He describes two innovations in micro-insurance that would benefit both the farmers and the insurance companies: in the first scenario, the farmer could purchase a weather-linked bond that would pay him in the event of an adverse weather event (thus diversifying the farmer's risk and negating the need for the company to verify actual crop losses); in the second, weather-linked bonds would be combined with financial services like loans and made out to large farm cooperatives for the purchase of seeds and fertilizers (the loan repayment would be reduced or waived if an adverse weather event occurred).
These financial plans, Sachs believes, could well enable African farmers to produce enough crops to feed the entire continent by giving them the resources necessary to invest in better technologies. At the same time, by minimizing the risks for the parties involved, they would encourage the once-wary insurance companies and lenders to complete more transactions with the farmers, providing benefits to both in the process.