CMER WORKING PAPER No. 08-62
Many developing countries are re-orienting their production and marketing systems by linking local agri-producers with organized supply chain networks and supermarkets to meet increasing consumer demands. However, the existing literature is silent on the effects of such integration on relative inefficiency of smallholder producers. This paper analyzes the effects of such supply chains using data from a natural experiment in the dairy sector of Pakistan. We study the impact of rural milk supply chain, known as milk district, on smallholder efficiency of commercial dairy producers by employing stochastic production frontier and technical inefficiency effects model using survey data of 800 dairy households. While location of dairy households in our sample is exogenously determined, building of milk supply chain indeed decreases technical inefficiency. We detect stronger power of milk district in further reducing technical inefficiency if the farms are located in remote areas, or if their size is relatively large. The advice to policy makers from these results conforms to the standard economic view that market competition leads to decreased levels of technical inefficiency of smallholder producers.