Nonparametric Evaluation of Economies of Scope in the Context of Technical Efficiency: The Case of Rice and Vegetable Farms in Korea

• Author: Kwansoo Kim,Donghwan An
• DOI: http://doi.org/10.1111/asej.12059
• Date: 01 September 2015
• Published date: 01 September 2015

Nonparametric Evaluation of Economies of

Scope in the Context of Technical Efficiency:

The Case of Rice and Vegetable Farms

in Korea*

Kwansoo Kim and Donghwan An

Received 20 December 2012; accepted 20 May 2015

This paper provides a nonparametric evaluation of economies of scope in the

context of technical efficiency allowing for non-convexity, with an application to

Korean rice and vegetable farms. Relying on non-parametric-free disposal hull and

data envelopment analysis approaches and input–output data for rice and vegetable

farms from the Korea Farm Household Economy Survey data collected in 2007,

this article examines technical inefficiency and its decomposition under non-

convexity and convexity. Empirical measures of technical inefficiency and its

decomposition results are provided, with a focus on a component of technical

inefficiency associated with economies of scope (i.e. diversification benefits) under

non-convexity in production technology. The decomposition measures of technical

inefficiency include pure technical inefficiency, size inefficiency and diversifica-

tion inefficiency. The results provide empirical evidence supporting size-dependent

diversification strategies, where benefits of diversification are larger for small

farms on average compared to those of large farms.

Keywords: data envelopment analysis, directional distance function, diversifica-

tion, economies of scope, free disposal hull, technical efficiency, size.

JEL classification codes: D22, D24, Q12.

doi: 10.1111/asej.12059

I. Introduction

The concept of economies of scope, proposed by Panzar and Willig (1981) and

Baumol et al. (1982), is a useful tool in investigating the existence, nature and

role of synergies and complementarities between production processes of a mul-

tiproduct firm. The concept has been widely used in measuring gains from

* Department of Agricultural Economics and Rural Development, Research Institute of Agricul-

ture and Life Sciences, College of Agriculture and Life Sciences, Seoul National University,

Gwanakro-1, Gwanak-gu, Seoul 151-921, Korea. Email: kimk@snu.ac.kr. An (corresponding author):

Department of Agricultural Economics and Rural Development, Research Institute of Agriculture and

Life Sciences, College of Agriculture and Life Sciences, Seoul National University, Gwanakro-1,

Gwanak-gu, Seoul 151-921, Korea. Email: dha@snu.ac.kr. Financial support from the LG Yonam

Foundation is gratefully acknowledged.

bs_bs_banner

Asian Economic Journal 2015, Vol. 29 No. 3, 285–301 285

© 2015 The Authors

Asian Economic Journal © 2015 East Asian Economic Association and Wiley Publishing Pty Ltd

multi-production processes compared with a fully specialized case in the context

of multiproduct industries, including higher education, the banking industry,

telecommunications, environmental management, the entertainment industry, the

multi-utilities industry and the hotel industry (e.g. De Groot et al., 1991; Ferrier

et al., 1993; Bloch et al., 2001; Beresteanu, 2005; Callan et al. (2001) Weng and

Wang, 2004; Farsi et al., 2007; Shin and Kim, 2011). This approach has

proven to be relevant for some cases, including the mergers of firms

producing different outputs where complete specialization is often applicable

(e.g. Bogetoft and Wang, 2005). However, there might be situations where

complete specialization is too extreme for comparison in evaluating economies of

scope. This is particularly relevant when a production process involves partial

specialization (e.g. Evans and Heckman, 1984; Berger et al., 1987). Agricultural

production provides a good example in this context (e.g. Mugera et al., 2008;

Mariano et al., 2011).

Economies of scope usually motivate diversified farm production activities in

agriculture (e.g. Fernandez-Cornejo et al., 1992; Chavas and Aliber, 1993;

Mafoua, 2002; Paul and Nehring, 2005). In Korea, farms are typically family

owned and run, with the manager of the farm being the head of the household and

family members primarily contributing the labor. Thus, for a small farm, we can

expect the gains from diversification to be closely associated with the joint input

use (e.g. labor and/or land) and/or positive externalities associated with diverse

production activities (e.g. benefits from crop rotation). In addition, in agriculture,

a partial specialization scenario appears relevant in production activities where

farms are usually involved in producing multiple outputs. As such, farms usually

do not fully specialize in one production activity. Thus, a partial specialization

case needs to be taken into consideration in investigating economies of scope in

agricultural production. For example, synergies across production processes

(i.e. positive externalities) and joint input use contribute to such diversification

benefits due to economies of scope.

The concept of economies of scope in the context of technical inefficiency

has received much interest in the literature (Färe, 1986; Grosskopf and

Yaisawarng, 1990; Bogetoft and Wang, 2005; and Cherchye et al., 2008;

Cumminsa et al., 2010; Ofori-Bah and Asafu-Adjaye, 2011). Technical ineffi-

ciency can be viewed as the inefficiency of a firm under evaluation compared

to another among a relevant set of firms. When compared to a set of firms

exhibiting different degrees of specialization/diversification, technical ineffi-

ciency might indirectly provide useful information on potential specialization/

diversification benefits. In particular, when a reference set is comprised of firms

with various degrees of specialization/diversification, a partial specialization

scenario can be incorporated into the evaluation of economies of scope. Thus,

a technical inefficiency analysis with a relevant reference set of firms can be a

useful tool for capturing partial specialization scenarios in the evaluation of

economies of scope (i.e. diversification benefits). This idea is motivated partly

by the recent work of Blancard et al. (2011), where potential gains from

ASIAN ECONOMIC JOURNAL 286

© 2015 The Authors

Asian Economic Journal © 2015 East Asian Economic Association and Wiley Publishing Pty Ltd