Results: comparative profitability

Since our interest is in the estimation of profit inefficiency and its determinants, we do not focus on the estimates of the stochastic profit frontier except for the derived profit elasticities. Table 4 [ PDF 71KB | 1 pages ] shows the profit elasticities with respect to the prices of the six variable inputs and the two fixed factors for both contract and non-contract farms. The profit elasticities of contract farms with respect to seed price, wage and energy are negative as expected yet not statistically significant, while the elasticities with respect to the prices of chemical fertilizer, organic fertilizer and machinery are positive yet insignificant.

As to the non-contract farms, the profit elasticities with respect to all the input prices are of the correct sign except for seed, which is also not statistically significant. For both contract and non-contract farms, profit elasticities with respect to the two fixed factors (land and capital) are also of the right sign but capital is not statistically significant. The estimated profit elasticities with respect to land are 0.87 for contract farms and 0.98 for non-contract farms, indicating that profit tends to increase by less than 1% with a 1% increase in land allocated to contract or non-contract rice farming.

We first test the hypothesis that ‘contract rice farmers are more profitable than noncontract rice farmers for comparable scales of operation.’ Full data on the calculations are given in the Appendix Table A.3 [ PDF 108.5KB | 3 pages ]. Here we focus on two distinct measures of profit one deducting only direct cash costs from sales revenue (‘profit over cash costs’) and the other deducting both cash and imputed non-cash costs (‘profit over total variable costs’). We place most emphasis on profit per unit of land (baht per rai).

The profit results are summarized in Table 5 [ PDF 95.6KB | 3 pages ], which shows that contract farmers had a significantly higher profit over total variable cost in the overall sample and in each region, but particularly in the Northeast. Contract farmers on the average generated a profit over total variable cost of 1,234 baht per rai in the North and 1,098 baht per rai in the Northeast. On the other hand, non-contract farmers produced a profit over total variable cost of 731 baht per rai in the North and only 273 baht per rai in the Northeast. Differences in profitability are less sharp (principally in the North) when costs include only cash costs excluding the imputed value of own inputs, like family labor and seeds (‘profits over cash costs’). Differences in profitability can largely be explained by the significantly higher price of rice received by the contract farmers (6.5. versus 6.0 baht/kg in the North and 7.9 versus 5.9 baht/kg in the Northeast). The marked difference in price for organic rice between the two regions is explained by the different price formulae used in private sector-based contract farming in the North and an NGO-based system in the Northeast. In the North the contracting firms offered a fixed margin of 0.5 baht above the market price of conventional rice at harvesting. In the North east the price was fixed at the start of the season based on negotiations between the NGO and the farmers. On the other hand, it is interesting to note that yield in kg per rai or was very similar for the contract and non-contract farmers in both regions. Average yields are considerably lower in the Northeast, however, due to a higher level land degradation.

Details of the cost structure of farms are given in Appendix Table A.3 [ PDF 108.5KB | 3 pages ]. In terms of the role of organic farming practices it is important to note that while contract farmers in the Northeast, contracted to an NGO with broader social objectives, appeared wholly organic with zero expenditure on chemical fertilizer, pesticides and herbicides, the transition and initial organic groups in the North continued to use them, due to an ineffective monitoring system operated by the contracting firms, although at lower levels per rai than non-contract farms. For example expenditure on chemical fertilizer per rai in the initial organic group was roughly two-thirds of that for conventional farms. Furthermore, organic farmers in the Northeast used more on-farm organic fertilizer than the contract farmers in the North. Invested capital assets (valued at baht per rai) were significantly higher for contract farmers in the North, while there was no significant difference between contract and non-contract farmers in the Northeast. Farmers in the North were generally far more capitalized than the Northeast.

Table 5 [ PDF 95.6KB | 3 pages ] also shows the differences in profit and cost structure among the three organic farmer groups – certified, transitory and initial – indicating their levels of sophistication in organic farming. While organic farmers in the North regardless of their stage of transition achieved similar levels of profit (in terms of profit over cash cost per rai), the certified organic farmers in the Northeast were considerably more profitable than the transitory and initial organic farmers. This is despite the fact that in the North, as we have just noted, there were considerable differences in terms of organic practices between the three different groups, with only the certified group being wholly organic. In the Northeast where profitability was generally lower than the North, the profitability of the initial organic farmers (defined as profit over cash expenditure), who continued to use chemical fertilizers, was roughly 25% above that of conventional farms. This profitability pattern can again be largely explained by the price of rice received by the farmers. While the price of rice was not significantly different among the three organic groups in the North, the price received by the certified organic farmers (10 baht per kg) in the Northeast was considerably higher than that received by the transitory and initial organic farmers (7.1 and 6.3 baht per kg respectively) and nearly double that received by non-contract farmers.

Table 6 [ PDF 90.2KB | 1 pages ] relates profit to farm size. Profit after cash costs for contract farmers per unit of land decreases with the increase in farm size, while for non-contract farmers profit after cash cost is more stable. We find no support for our third hypothesis and conclude from this that contract farming as practiced in these areas of Thailand does not seem to be biased against smaller farms in terms of profitability, as is sometimes argued. Furthermore, for all farm sizes profits are significantly higher for contract farmers, as compared with non-contract farmers.

Selection bias and counterfactual simulation

The above profitability comparison reveals that contract farms in the sample generally have higher profits than non-contract farms. However, this profitability difference does not necessarily indicate that contracting has a positive impact on profits because it could be caused by selection bias. That is, the higher profitability in contract farming may merely reflect the fact that farms with the potential of securing higher profitability are more likely to become contract farms. In other words, these contract farmers might have relatively high profits whether engaging in contract or non-contract farming.

A counterfactual simulation can help sort out the impact of contracting on profitability. In brief, the key to this approach is to estimate farms’ counterfactual profits and compare these to their actual profits. The counterfactual profit of a contract farm is defined as the hypothetical profit that it could have earned had it farmed like a (typical) non-contract farm. Similarly, the counterfactual profitability of a non-contract farm is defined as the hypothetical profit that it could have earned had it farmed like a (typical) contract farm. Non-contract farms in the sample generally sold their rice at lower prices than contract farms. We use the rice prices of contract (or non-contract) farms in the estimation of the counterfactual profits of non-contract (or contract) farms. Higher actual than counterfactual profits for contract farms would indicate that contract farms would have been less profitable had they operated like a non-contract farm. Similarly, lower actual than counterfactual profits for non-contract farms would indicate that non-contract farms would have been more profitable had they operated like a contract farms.⁵

The counterfactual results are given in Table 7 [ PDF 70.7KB | 1 pages ]. Had contract farms operated like a non-contract farm, their counterfactual profits would (on average) have been 31% lower than their actual profits; the differences are 49% and 21% respectively for contract farms in the North and Northeast. Conversely, had non-contract farms operated like a contract farm, their counterfactual profits would have been 47% higher than their actual profits; the differences are 9.4% (significant at 10% level) in the North and 72% in the Northeast. These results clarify that the observed higher profitability in contract farming is not simply because of contract farming attracting the more profitable farms; rather, it is evidence supporting the hypothesis that contract farming tends to be more profitable than non-contract farming.

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