Sodbusting, Crop Insurance, and Sunk Conversion Costs

Abstract

We build a real option model that articulates sodbusting incentives arising from risk interventions in the presence of conversion costs. The model shows that risk interventions reduce expected costs of switching land use between cropping and noncropping activities and, hence, incentivize sodbusting. Based on data for south-central North Dakota over 1989–2012, our simulations show that offsetting 20% of a cropping-return shortfall by a risk intervention increases the sodbusting cost threshold, below which sodbusting will occur, by 41% (or $43.7/acre). Omitting cropping-return risk across time underestimates the sodbusting cost threshold by 23% (or $24.35/acre) and hence underestimates sodbusting caused by crop production. (JEL Q18, Q38)