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The 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 the 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 has decreased over time. In 1996 costs could have been reduced by close to 30% by full exploitation of the 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, which corresponds almost exactly the total public support to the dairy farms in 1996. The non-exploited scale-economies are largely due to the agricultural policy. Thus a substantial share of them 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, among other things, that technical innovations and other efficiency-improving investments are not carried out. This is the more likely explanation for the extremely poor efficiency development in Norwegian dairy production in the period studied.