Gains and structural effects of exploiting scale-economies in Norwegian dairy production

In this paper, we present calculations of the economic gains in terms of reduced costs by exploiting scale-economies in dairy production in Norway, and the effect this would have had on the number of farms. We also explore whether or not optimal scale and unexploited scale-economies change over time due to scale-augmenting technical change. The analysis is based on homothetic cost functions estimated by means of data for individual dairy farms for the period 1972-1996. For 1972, we find that, by full exploitation of scale-economies, the costs could have been reduced by almost 40%, while the number of farms would have been reduced by more than 85%. The number of small farms has been substantially reduced in the period considered. This fact, combined with small scale-augmenting technical change, implies that the gains and structural effects of exploiting scale-economies have decreased over time. In 1996, costs could have been reduced by close to 30% by full exploitation of scale-economies, while the number of farms would have been reduced by slightly more than 70%. Thus, both gains and structural effects are substantially less than in 1972. Nevertheless, the calculated gains for 1996 make almost 5 billion NOK. This corresponds almost exactly to the total public support to the dairy farms in 1996. The unexploited scale-economies are largely due to the agricultural policy. Thus, a substantial share of the same can be considered as part of the 'price' the Norwegian society has to pay for this policy. In addition, there are likely to be large hidden costs of this policy due in particular to the quota system and other direct production regulations. They imply that technical innovations and other efficiency-improving investments requiring increased production to be profitable are not carried out. This is the more likely explanation for the extremely poor efficiency development in Norwegian dairy production in the period studied.