On the role of risk versus economies of scope in farm diversification with an application to Ethiopian farms

This article investigates the economics of farm diversification. The analysis assesses economies of diversification using a certainty equivalent measure. It identifies two components: one associated with expected income, and one associated with risk exposure. This integrates two lines of research explored in previous literature: economies of scope and risk management. We examine the roles played by complementarity, scale and concavity effects in economies of diversification. The approach is applied to diversification decisions made on Ethiopian farms, with a focus on production uncertainty. The econometric analysis finds large complementarity benefits, providing incentives to diversify. But this is tempered by (non)-concavity effects that provide incentives to specialise. The analysis also documents how risk affects diversification, including both variance and skewness effects. It provides new insights on economic tradeoffs between farm diversification and specialisation