Sunday, 7 October 2012

The family owned farm

Over at Homepaddock Ele Ludemann is discussing the ownership of farms and the profitability of farms:
These are usually larger family owned businesses. They have economies of scale that smaller ones lack and don’t have problems of governance and management which often dog corporate farms.

However, while profitability is essential for the long-term health of any business, money isn’t all that matters.

From my observation family owned and run farms are more likely to take a longer term view and seek to balance economic, environmental and social factors in their businesses.
This obviously is an important (and interesting) topic for a farming country like New Zealand. As noted by Ele an odd fact about farming is that family-based firms still dominate the industry. This is unusual given that most other industries are dominated by investor owned firms, so why isn't farming?

The short answer given by Allen and Lueck (1998) and Allen and Lueck (2002) is "nature". They argue that farms operate in unique circumstances defined by nature, in particular seasonality. This is the main feature that distinguishes farm organisation from industrial organisation.

For farmers a season is a distinct period of the year during which a given activity is optimally undertaken. This is key to understanding the why the incentives generated within agriculture favour family farms. The two basic issues are opportunities for hired workers to shirk due to random production shocks from nature and the limits on the gains from specialisation and the timing problems caused by seasonality. The trade-off between effect work incentives and gains from specialisation help determine the costs and benefits of different farm organisational types.

The family farm model provides the best work incentives since the owner is the sole recipient of the benefits, but this model misses some benefits due to specialisation. This follows from the fact that the farmer must engage in numerous different tasks during each stage of production, and in addition, numerous production stages throughout the year.

On the other hand, large factory-style corporate farms gain from a specialised labour force and lower cost of capital, but suffer from bad worker incentives since hired workers, not being one of the owners, have an increased incentive to shirk.

To some degree all firms are governed by the trade-off between gains from specialisation and work incentives. For the case of farming it is the unique, large impact of nature that biases it towards family operations.

An obvious, but key, feature of agriculture is that it involves a living, growing product. In the case of livestock, for example, you have breeding, husbandry, feeding and slaughter. Such a cycle is largely governed by nature. In principle there is no reason that a different farmer could not own each stage. But timing difficulties between stages result in high costs of engaging in market transactions. Such timing issues are particularly severe in farming because the inventories of the intermediate goods cannot be held given the living nature of the product.

There are a number of factors, such as the number of crop cycles, the length of the production stages and the number of tasks within a stage, which also influence wage labour incentives. When cycles are few, stages are short, random shocks are large and the tasks are few, there is little to gain from specialisation and labour is especially costly to monitor. Thus family farms.

If these issues can be overcome, that is, if farmers can mitigate seasonality and random shocks to output, farm organisation starts to look much like that in the rest of the economy. Under such conditions farm organisation will gravitate towards factory process and develop the large-scale corporate forms of other sectors of the economy.

Another issue that family ownership of farms raises for theory of the firm types is, Are farms firms? An answer of Yes may seem obvious, but a little thought could suggest otherwise.

In Spulber (2009) Daniel Spulber defines a firm
"[ ... ] to be a transaction institution whose objectives differ from those of its owners. This separation is the key difference between the firm and direct exchange between consumers". (Spulber 2009: 63).
Note that under this definition organisations such as family owned farms - along with other types of family owned businesses, clubs, basic partnerships, worker cooperatives, non-for-profit organisations and public enterprises - are not firms. The basic reason being that the objectives of these types of organisations cannot be separated from those of their owners.

  • Allen, Douglas W. and Dean Lueck (1998). "The Nature of the Farm", Journal of Law and Economics, 41: 343-86.
  • Allen, Douglas W. and Dean Lueck (2002). The Nature of the Farm: Contracts, Risk, and Organization in Agriculture, Cambridge Mass.: The MIT Press.
  • Spulber, Daniel F. (2009). "The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Firms, Markets, and Organizations", Cambridge: Cambridge University Press.


Mark Hubbard said...

What a pity that the associated persons rules within our tax legislation now often make family farm transactions, particularly restructuring and succession, more difficult, and more expensive, than dealing with complete stranger third parties.

For example, if your herd is on the Herd Scheme, you are a company and you sell to third party: no issues. Sell to your son or daughter, you create a disastrous dividend, so end up in convoluted restructurings to try and put you back on the same footing, that probably half the time imperil you on the tax avoidance provisions.

I can see why the associated person rules exist, however, the unintended consequence (as with the welfare state) has been to make things even harder for the traditional family unit.

Paul Walker said...

Mark, yes tax is an issue with all forms of business organisation. The thing about farming is that the tax treatment of it differs widely around the world and yet we see family farms all around the world. So something in addition to tax is driving the use of the family farm.

Horace the Grump said...

I think you are significantly over simplifying the structure of farming - specialisation in different stages of the 'nature' cycle is definitely increasing... witness the emergence of dairy support blocks owned by people who only do that, or specialist finishing properties - where the farmers only engage in 'finishing' stock before going to the 'works'...

Also witness the emergence of the specialist farm manager as a career professional.

Three very quick examples off the top of my head...

homepaddock said...

There's also what Bill English refers to as the live it and love it factor: