Estimating the Profit Efficiency of Contract and Non-Contract Rice Farms in Taiwan -- A Meta-Frontier and A Cross-Frontier Appraoch Applications

Purpose - Contract farming has been proposed as an avenue for private sector to take over the roles previously served by the government in the provision of information, inputs or credit for small-scale farmers in the developing countries (World Bank, 2001). Increasing attention has been given to whether contract farming can provide small farmers with improved income or sufficient protection from incurring losses due to price fluctuations. In the literature, the positive relationship between the use of contracts and the increasing productivity is found (Cochrane, 1993, and Ahearn et al., 2005). A fair amount of effort has been directed at assessing the relative efficiency of contract farming over independent production. Knoeber (1989) showes that the use of production contracts in the hog and broiler industry help the diffusion of the new technologies and lead to the improvement of productivity. Key and McBride (2003) provide evidence that contracts are associated with high productivity performance in hog production in the U.S. Morrison et al. (2004) shows that smaller operations are in general less efficient than larger and more contract-intensive entities. This finding not only suggests competitive pressures on smaller farms but also point out the barriers for smaller growers to participate in contract farming scheme. For developing countries, Ramaswami et al. (2006) evaluate how the efficiency gains of poultry contracts are shared between growers and processors in India. Cost reduction from better technology and production practices is counted as efficiency gain for the processors, while average return is viewed as efficiency gain for the growers. However, there is little direct evidence regarding the potential of contract farming to increase profitability through increases in profit efficiency. Setboonsarng et al. (2005) use a stochastic profit frontier model to examine the profit efficiency of organic rice contract farming in the north and northeastern regions of Thailand. They identify a significant profit margin for contract farms across all scale of operations as compared to the non-contract farms, but efficiency gain is not as significant for the largest farm sizes. In our study by using a very special survey data from Taiwan, besides the technology/productivity efficiency, we will be able to compare the profit efficiency between contract and non-contact farms. Design/Methodology/approach - The profit inefficiency is defined as loss of profit from not operating on the profit frontier (Ali and Flinn, 1989). It can be measured by the following Rahman (2003)’s approach in which both technical and allocative inefficiency are simultaneously taken into account. Technical inefficiency is defined as the loss of profits from failing to meet the production efficient frontier. Allocative inefficiency is the loss of profits from failing to observe or respond to the relative prices of inputs and outputs. The stochastic profit frontier is defined as , where π is the vector of profit defined as gross revenue minus variable cost; p and w are the vectors of output and input prices, respectively; and Z is the vector of fixed inputs. A meta-frontier methodology of Battese et al (2004) is adopted to estimate simultaneously the efficiencies and the technological gaps for productions under different technologies relative to the potential technology available as a whole as well. Another approach that is based on Cummins et al (1999) is also applied to estimate the cross-frontier profit efficiency. Findings - The estimation result indicates that an average contract farms is 20 percent more efficient than an average non-contract farm under a comparable operating environment. We also find that the contract decision is determined not only by a profit comparison between contract and independent producers but also by other demographic determinants like age, education level, employment status and geographical locations. Finally, we find that contract rice farmers have more profit efficiency than non-contract rice farmers given a profit meta-frontier function. Originality/value/discussion - Contract farming has become an attractive policy instrument for many developing countries to assist small family farms to gain access to markets, information, credits, and necessary services to manage their risk. This study uses a very special survey data from Taiwan, including more than 300 rice farmers. Besides the technology/productivity efficiency, we compare the profit efficiency between contract and non-contact farms, which is not commonly seen in the literature. Our results imply that the contract arrangement can indeed be an effective institutional mechanism to increase profitability and competitiveness for small family farms.