Decoupling Policy Effect and Irish Dairy Farms Productivity Estimation Using Olley/Pakes

The recent Common Agricultural Policy (CAP) reform of the financial support mechanism for farms was introduced in 2005. According to this reform, the level of support that each farm receives is paid regardless of the current level of production. The decoupling of direct payments is expected to change production decisions, as farmers will change their mainly subsidy revenue maximization objectives to profit maximizing behaviour, which is market oriented. Irish dairy farms present an interesting setting for studying the dynamics of farms’ adjustment process in a changing agricultural policy environment, in particular in relation to productivity changes. One of the goals of this paper is to test the hypothesis that the uncertainties associated with increased price volatility, the uncertainty concerning the scheme itself and lucrative investment grants encouraged dairy farmers to stay in business, thereby making bad capital investment decisions and using decoupled payments to subsidise their production activities. This paper contributes to the literature in the following ways: first, we estimate production functions for dairy farms using a modified Olley/Pakes (OP) methodology; second, we compare productivity trends estimated by Stochastic Frontier Analysis (SFA) and modified OP techniques, and discuss possible reasons for differences in these trends; third, we introduce SFA efficiency estimates as a proxy for the probability of survival in the OP estimation procedure, and evaluate the influence of possible selection bias; finally, we investigate the effect of decoupling on Irish dairy farmers’ productivity using the modified OP productivity estimation results.