Methodology

The chapter employs the profit frontier methodology to assess the profitability and profit efficiency of the sampled Thai rice farmers. Profit efficiency is defined here as the ratio of the observed profit to the potential maximum attainable profit. While profit provides a direct measure of relative competitiveness of one type of farm (that is a contract farm) in relation to others (that is a non-contract farm), the concept of profit efficiency can also be useful as an indicator of relative competitiveness. We also attempt to account for selection bias using a two-stage switching regression model. The estimated models are used for subsequent ‘counterfactual’ simulations of profit and profit efficiency.

1. Contract rice farmers are more profitable than non-contract rice farmers for comparable scales of operation; and
2. Contract rice farmers are more (profit) efficient than non-contract rice farmers for comparable scales of operation.
3. Contract farming is biased against small farmers.

Since all contract rice farmers in the sample are certified organic or in transition to becoming organic farmers and all the non-contract farmers are conventional rice farmers, the analysis also throws some light on the debate concerning organic versus conventional agriculture. However the evidence on this must be interpreted with care and it is difficult to draw firm conclusions. This is partly because we cannot separate the effects of an institutional arrangement (a contract) from a technology (organic farming practices) as the contract farming group is influenced by both. Further not all contract farmers are certified organic farmers who have completed the required three year transition period, although we can distinguish between the pure (or certified) organic farmers from those who are either in transition or just starting out to adopt organic practices.

Efficiency and profit frontiers

Efficiency and inefficiency can generally be measured by its components - technical, cost, revenue and profit. Technical efficiency refers to a farm’s ability to produce the maximum outputs for a given set of inputs and technology. Or conversely, it can be measured as the farm’s ability to utilize the minimum amount of inputs to produce a desirable set of outputs for a given technology. Cost efficiency refers to the ability of the farm to minimize the expenditures required to produce a desirable set of outputs, given their respective input prices and production technology. Misallocation of inputs contributes to cost inefficiency and is sometimes refers to as input allocative inefficiency. Revenue efficiency refers to the farmer’s ability in allocating their outputs in a revenue-maximizing manner for a given set of output prices. Finally, profit efficiency refers to a farm’s ability to obtain maximum profit for a given set of input prices, output prices, and technology. While technical, cost, and revenue efficiency are necessary for the achievement of profit efficiency, they are collectively not sufficient for profit efficiency. Profit efficiency further requires that technical, cost and revenue efficiency be achieved at the proper scale, that is it requires some kind of scale efficiency (Kumbhakar and Lovell, 2000).

Here we utilize a dual variable profit frontier, which portrays the maximum variable profit (defined as gross revenue less variable cost) obtainable by a farm given the prices of inputs and outputs, the production technology, and the presence of fixed inputs such as land and capital. The variable profit frontier is more appropriate when farms do not have the flexibility to adjust all inputs. Farms operating on the profit frontier are profit efficient while farms operating under the profit frontier are profit inefficient.¹

Other studies using profit frontier analysis

In terms of the wider literature, while rice is perhaps the most studied agricultural commodity by researchers, very few have used profit frontiers, which could be due to lack of appropriate data. In a review article by Bravo-Ureta and Pinheiro (1993) on efficiency analysis of developing country agriculture, 13 out of 20 studies were on rice farming. However, only two studies used the dual profit frontier approach and only one was on rice farming. Ali and Flinn (1989) used a single equation dual profit frontier to examine the efficiency of 120 rice producers from the Punjab in Pakistan. They found that the average inefficiency was 31%. Education was found to have a significant role in reducing profit inefficiency, while off-farm employment and difficulties in securing credit to purchase fertilizer tended to increase profit inefficiency. The other study by Bailey et al. (1989) is on dairy farms.

Since 1993 a few more studies have employed profit frontiers. Abdulai and Huffman (2000) used a stochastic translog profit frontier to examine the efficiency of 256 farmers in the Northern region of Ghana. They found that the average inefficiency was 27.4%. Their inefficiency analysis suggested that the education of the household head, access to credit, greater specialization, and location in districts with better access to extension services and better infrastructure were significant variables for increasing profit efficiency. On the other hand, increasing participation in nonfarm activities by farmers and being older tended to lower profit efficiency. Rahman (2003) also used a dual profit translog frontier to investigate the efficiency of 380 farms, which produced a modern variety of rice in three agro-ecological regions of Bangladesh. He found that the average inefficiency was about 23%. Farmers with more experience in growing modern varieties of rice, better access to input markets and extension services, located in fertile regions, as well as those with less off-farm work and who owned their land were found to be more efficient.

To our knowledge, there are no other efficiency studies on rice farming which employ the stochastic profit frontier approach. However, there are several efficiency studies of other agricultural products using the stochastic frontier approach since the 1993 review article by Bravo-Ureta and Pinheiro. Arajuo and Bonjean (1999) used a stochastic profit frontier to study the efficiency of different land tenure patterns in Brazilian farms. Bhattacharyya and Glover (1993) also employed a stochastic profit frontier to examine the efficiency of small versus large farms in India. Wang et al (1996) developed a shadow-price profit frontier model to examine the efficiency of Chinese rural households in farming operations. Delgado et al (2003) employed the profit frontier approach to investigate the efficiency of large versus small and contract versus independent livestock farms in the Philippines, India, Thailand, and Brazil.

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