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1.5 Hypotheses to be Tested

The research issues above can be investigated by a number of means, but lend themselves especially well to empirical investigation and testing of a number of specific hypotheses.

Hypothesis 1: Small-scale producers have lower profits per unit of output than do large producers.

This can be directly calculated from farm survey data, and represents a benchmark. If false, smallholders still have a chance to compete. If true, it is unlikely that smallholders will be able to compete in the same markets as larger-scale producer. Even if not true, there is still the possibility that large-scale producers will drive them out of the market by reducing prices if the large-scale producers are more efficient users of resources.

Hypothesis 2: Large-scale producers are more efficient users of farm resources to secure profits, other things equal.

This issue requires an analytical methodology for empirical testing (see Chapter 4 below). By "efficiency" is meant the amalgam of technical efficiency in terms of producing the most output with a given set of inputs and allocative efficiency, in terms of using the most efficient combination of inputs given prevailing prices. If hypothesis one above and the present hypothesis both fail to hold, the outlook for smallholders is pretty good, since the combination of higher unit profits and greater efficiency would mean that they could either displace large farmers, or possibly eventually become large farmers!

If hypothesis one holds and two does not, then smallholders may evolve to a position of being able to compete effectively with large-scale operations. If both one and two hold, there is little apparent scope for keeping smallholders involved without explicit subsidies for this purpose, and even then it is unlikely that their presence will be felt for long.

A spin-off sub-hypothesis here is that the relative profit efficiency of small farms compared to large ones depends greatly on how family labor input is valued in both cases. Since family labor is a much higher share of total labor on smaller farms, not valuing family labor favors the estimated relative efficiency of smallholders. In fact, it seems likely that one way smallholders avoid being displaced is by under-valuing their own labor relative to market wage rates paid by commercial operators for similar work. If this turns out to be the basis of smallholder competitiveness, then the latter is likely to become more fragile as labor markets become more integrated over time.

Hypothesis 3: Small-farmers expend a higher amount of effort/investment in abatement of negative environmental externalities per unit of output than do large farmers.

This hypothesis requires an empirical approach for measuring externalities that can be attributed to specific farms (see Chapter 4 below). If such a methodology is feasible, then it allows addressing indirectly a fascinating question: do large farmers reap more benefits per unit of output from environmental externalities than do small ones? If so, lack of enforcement of environmental laws is probably contributing to scaling-up. If not, smallholders may have been able to hang on in the livestock sector in part because they get away with pollution and larger scale operators did not. However, increasing densities of smallholders producing livestock near human population centers under the Livestock Revolution will bring increasing problems.

Hypothesis 4: The relative profit efficiency of large-scale farms is more sensitive to environmental externalities than is the case for small farms

If small farmers internalize a higher share of negative externalities than do large farms, as per hypothesis 3 above, it stands to reason that environmental externalities are one component of the hypothesized greater profit efficiency of large farms. However, a model is required to test hypothesis 4, even if descriptive analysis is enough to support the assertion in hypothesis 3. This is because the value of an uncompensated externality to the relative profit efficiency of a given farm is just one of many influences, and may also be correlated with other relevant factors. Empirical methods to assess the differential impacts of uncompensated externalities on relative profitability must also account simultaneously for all the other factors that explain differences in profitability across farms, especially differences in technical and allocative efficiency and differences in policy distortions and transaction costs as they impact on different farms. If a satisfactory approach to these problems can be devised, then the pay-off is an unbiased view of the relative importance of uncompensated environmental externalities in promoting scaling-up.

Hypothesis 5: Profits of small-scale producers are more sensitive to 'transaction costs' than are those of large-scale producers.

The probability of this being the case is very high, and if true, it suggests that policies that reduce transaction costs for all producers will be of particular benefit to smallholders. It also suggests that institutional solutions to high transaction costs such as dairy coops and contract farming will be of greatest benefit to smallholders. However, there are methodological problems in investigating this issue. First, transaction costs are typically not observable, and therefore must be inferred from farm characteristics that are likely to be collinear with differences in access to information and assets. Second, there is a similar problem to the one under the previous hypothesis, involving sorting out different influences on relative profitability. As before, a satisfactory approach to these joint problems will yield an unbiased view of the relative importance of different kinds of information or asset asymmetry in promoting scaling-up.

Hypothesis 6: Contract farmers have higher nominal profits per unit compared with independents of similar scale

As noted above, the primary antidote to transaction costs issues of smallholders is the creation of institutions of collective action that help overcome the transaction cost barrier. Contract farming is often advanced as the salvation of the smallholder in the livestock area. The research issue therefore is to observe a sample of contract and independent farmers, and see how the institution represented by the contracts of the contract farmers changes the analysis above. From a policy perspective, it will also be important to know if the higher profitability of contract farming is due in part to implicit or hidden subsidies received by the integrating institution.

Hypothesis 7: Contract farmers are more profit efficient than independent farmers for comparable scales of operation

If contract farming is a way around the high transaction costs plaguing smallholders, then it should increase the efficiency with which they use their fixed farm resources to secure profits, in addition to their average unit profits. If this is the case, contract farming where it is appropriate could keep small-scale farms participating in high-value markets for some time to come.

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