The Dual Role of Insurance in Input Use : Mitigating Risk Versus Curtailing Incentives

Insurance can encourage the use of risk-increasing inputs, but it can also decrease people's incentives to exert effort when it is difficult to monitor how much they exert themselves. This effort reduction can go hand in hand with a decrease in the use of effort-complementary inputs. I study a model of risk-sharing that allows for both effects of insurance on input use and use the latest ICRISAT panel to structurally estimate it. Median fertilizer use is between 1.3 and 3.6 times higher under no sharing than under full insurance. A subsidy that halves the purchase prices of fertilizer increases farmers' welfare by 8% in consumption-equivalent terms