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Custom-hired tractor services and returns to scale in smallholder agriculture: A

production function approach

Article  in  Agricultural Economics · May 2017

DOI: 10.1111/agec.12339

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1
Custom-hired tractor services and returns to scale in smallholder agriculture: A production

function approach

Hiroyuki Takeshima

2033 K Street, NW

International Food Policy Research Institute

2033 K Street, NW, Washington DC

E-mail: H.takeshima@cgiar.org

Phone: +1-202-862-8195

2
Abstract: Historically, agricultural transformation has often accompanied the

increase in the returns to scale. Little direct evidence exists, however, on what

actually causes such increase, despite the knowledge of many factors that are

associated with this increase. We fill this knowledge gap by testing whether hiring

in tractor services has raised returns to scale in agriculture at the household level

in Nepal Terai that has undergone rapid growth in the tractor use through custom-

hiring services. Using Switching Regression and Inverse-Probability-Weighted

Generalized Method of Moments, we address two sources of endogeneity

involved with the estimation of returns to scale; (a) farmers’ self-selection on

whether to hire in tractor services; (b) use of inputs in the production function.

For both Cobb-Douglas and Translog production function specifications, we find

that hiring in tractor services significantly increased the returns to scale in

agricultural production by about 0.2 ~ 0.3 among farm households not owning

tractors, for which suitable control groups are found. Findings are robust under

various alternative specifications.

Keywords: agricultural mechanization through tractor hiring, returns to scale, production

function, inverse probability weighted estimator, Nepal Terai, agricultural transformation

JEL classification: O13, Q12, Q16

3
 Acknowledgments

I would like to thank the participants of Stakeholder Consultation Meeting held in

Kathmandu, Nepal, on September 2015, two anonymous referees and the editor of the journal for

providing constructive comments. The paper has also benefited from constructive dialogues with

Xinshen Diao, Nazaire Houssou, Scott Justice, Anjani Kumar and Xiaobo Zhang. This work was

undertaken as part of and funded by the CGIAR Research Program on Policies, Institutions, and

Markets (PIM) led by the International Food Policy Research Institute (IFPRI) and the United

States Agency for International Development (USAID) Food Security Policy project (FSP). The

author is responsible for any remaining errors.

4
1. Background

Agricultural transformation often accompanies a growth in returns to scale (RTS).

Estimating a cross-country Cobb-Douglas production function, Hayami and Ruttan (1985 pp.

148) shows that the production functions differ between developed and developing countries by

the larger scale factor for the former, while input shares are relatively similar. Constant or

increasing RTS is often observed for developed countries’ agriculture, while diminishing RTS is

prevalent in the developing countries’ agriculture (Adesina and Djato, 1997; Craig et al., 1997).

In Japan, agricultural RTS had increased despite the dominance of small farms (Hayami and

Kawagoe, 1989). The change in RTS has significant implications for agricultural policies. With

the same total factor productivity, greater RTS often induces greater intensification, as input use

often becomes more price responsive, so that price policies can have greater effects. The RTS

also affects the relationship between farm size and productivity (Foster and Rosenzweig, 2011;

Deininger and Byerlee, 2012), and thus the structure of the agricultural sector.

What raises RTS in agriculture has, however, not been well understood in the literature.

Studies associate the increase in RTS with various factors, including specialization, land

consolidation (Wan and Cheng, 2001), a change of crop mix (Cramb, 2011), or breeding of pest-

resistant varieties that reduce labor monitoring costs (Deininger and Byerlee, 2012), as well as

mechanization (Foster and Rosenzweig, 2011; Christiaensen, 2013). Few studies, however, have

established the direct causality. It is possible that RTS is increased by other factors, and such

increase in RTS may be inducing demand for specialization, change in crop mix, development of

new varieties, or intensive mechanization.

We fill this knowledge gap by testing the hypothesis that the adoption of services

provided with tractors (tractor services, TS hereafter) through custom-hiring (hiring-in of TS,

5
HTS hereafter) “increases” the agricultural RTS among non-owners of tractors. We focus on

non-owners of tractors, because many smallholders using tractors in developing countries rely on

HTS instead of investing in own machines (Diao et al., 2014; Benin, 2015; Takeshima et al.,

2015a), and also because of methodological constraints as is described in later sections. Our

analysis therefore does not cover tractor owners whose hiring out services are often behind the

growths of smallholder mechanization through HTS in developing countries (Benin et al., 2013;

Diao et al., 2014; Takeshima et al., 2015a). Future studies investigate the contributions of tractor

owners on the change in agricultural RTS.

Our analysis focuses on the lowland (Terai) zone of Nepal in 2010, using the Nepal

Living Standard Survey collected in 2010 (NLSS 2010 hereafter) by the Central Bureau of

Statistics of Nepal. In Nepal Terai, the share of tractor-using farm households increased

relatively fast, from 9% in 1995 to almost 49% in 2010, primarily through HTS (Takeshima et

al., 2015b). During this time, key production factors among nonhirers might not have adjusted

fast enough, and the production functions of nonhirers in 2010 may still exhibit significant

differences from that of TS-hirers. Focusing on Nepal Terai in 2010 therefore can detect the

potential difference in RTS due to HTS. For example, the trends in agricultural capital (see

online Appendix A for its definition) and area cultivated, which we show later as major inputs in

the production functions, provide partial evidence for this, based on author’s calculations using

the NLSS 2010 as well as two other rounds (1995, 2003) not used in this study. Between 1995

and 2010, the average value of agricultural capital holdings of farm households in Nepal Terai,

when measured in the equivalent of kg worth of cereals, had changed only slightly from 2900 in

1995 to 3000 in 2003 and 3300 in 2010. Average area cultivated in Nepal Terai during this

period had declined from 2.4 ha in 1995 to 2.0 in 2003 and 1.4 in 2010. These patterns are

6
consistent across both TS-hirers and nonhirers. Therefore, neither agricultural capital

accumulation nor farm size expansion in Nepal Terai is driving the growth in RTS that we show.

In the robustness check section, we also show that we are capturing the effects of HTS per se,

and not the effects of other endogenous inputs uses that may be correlated with HTS.

We specifically test whether the HTS raises the RTS measured as the sum of factor

coefficients in production functions, address endogeneity from two sources. First, the decision of

HTS may be endogenous to the changes in RTS. Second, inputs in the production functions may

be endogenous to the output. We address them jointly through switching regression Generalized

method of moments (SR-GMM) estimator as well as inverse-probability-weighted Generalized

method of moments (IPW-GMM) estimator.

We contribute to the literature in various ways. The mechanization literature suggests that

agricultural mechanization often leads to farm size expansion (ex., Houssou and Chapoto, 2014),

or is associated with larger farm size (ex., Binswanger, 1986; Pingali, 2007; Otsuka et al., 2013;

Yamauchi, 2016). It has, however, not investigated whether mechanization simply complements

land and substitutes land-saving inputs within the fixed production function (and thus not

affecting the RTS), or it affects the production function itself (thus affecting the RTS). We partly

fill this knowledge gap by showing evidence for HTS. Lastly, we contribute to the literature on

impact evaluation methods, by showing how the causal effect of technology adoption on the

endogenous production relations can be estimated.

2. Hiring in of tractor service and returns to scale

HTS may increase the agricultural RTS through various mechanisms. Mechanical power

may mitigate the rapid decrease in marginal productivity inherent in human or animal powers

7
due to drudgery and supervising costs (Foster and Rosenzweig, 2011). Timely land preparation

with mechanical power may mitigate the decrease in the marginal land productivity due to the

delayed planting on certain sections of plots, as is often found in developing countries

(Haggblade, 2005). Using tractors for transporting harvests may allow timely market

transactions, mitigating the decrease in returns to agricultural capital like processing machines

and private storage facilities. This might also increase feed crop harvests. Combined with the

timeliness in transporting fresh animal products, RTS in livestock holdings may increase.

Alternatively, HTS may increase the RTS through greater backward and forward linkages

and outsourcing of the supply of inputs and services. Outsourcing of TS may keep the marginal

costs of land preparation relatively constant. Timely land preparation may allow planting of

homogeneous varieties that grow, flower and mature at the same time. This may induce sourcing

of larger quantities of homogeneous seeds from the market, rather than relying on diverse

varieties that are more suitable for varying land preparation dates. With an increase in RTS of

physical production, farmers may demand more inputs and services from the market, which

exhibit relatively constant marginal costs, relative to internally supplied inputs and services

which tend to exhibit increasing marginal costs. The use of tractors for transportation may allow

greater use of purchased inputs (rented draft animal for secondary tillage, small threshing

machines, rented irrigation pump, etc.), while transport of harvests may increase the demand for

off-site services (milling services, storage facilities).

However, these mechanisms may not always raise RTS if the primary function of

mechanical power by tractor is simply to substitute a relatively small fraction of overall labor

used. The rise in RTS is also limited if the benefit from timeliness is minimal due to either the

low influence on planting date (because of sufficient irrigation access, or climatic conditions),

8
the existence of alternative transportation methods, among others.

3. Empirical framework

3.1. Conceptual framework

RTS measures the elasticity of output increases with respect to increases in all inputs at a

fixed proportion. It is in one way measured as the sum of the output elasticities of all inputs in a

production function (Kislev and Peterson, 1996). The effect of HTS on RTS can be investigated

in the following framework. A farm household belongs to one of two production systems, (a)

with TS (denoted as regime 𝑅 = 1), and (b) without TS (𝑅 = 0). Output 𝑌 is realized in one of

the regimes that the farmer belongs to;

𝑓1 (𝐾1 ; 𝐴) if 𝑅 = 1
𝑌={ } (1)
𝑓0 (𝐾0 ; 𝐴) if 𝑅 = 0

in which 𝑓𝑅 ’s are regime specific production functions that relate inputs / services vector 𝐾𝑅 ,

with output Y, given agro-ecological and socio-economic conditions, 𝐴.

The farm household chooses 𝑅 and 𝐾𝑅 that maximize utility U that depends on the

agricultural profit 𝜋;

max 𝑈(𝜋) (2)

𝑅,𝐾𝑅

𝜋 = 𝑅 ⋅ [𝑓1 ⋅ (𝐾1 ; 𝐴) − 𝑐1 (𝑤, 𝐾1 )] + (1 − 𝑅) ⋅ [𝑓0 ⋅ (𝐾0 ; 𝐴) − 𝑐0 (𝑤, 𝐾0 )], (3)

where 𝑐𝑅 (𝑤, 𝐾𝑅 ) is the cost of using 𝐾𝑅 given 𝑤, a vector of factors affecting inputs costs

(including opportunity costs of family labor) standardized by setting output price at 1, and a set

of constraints (liquidity constraints, etc.) which are expressed as

𝑔𝑅 (𝐾𝑅 , 𝐴, 𝑤, 𝜂) ≥ 0, ∀𝑅. (4)

where 𝜂 is a set of factors affecting the liquidity of the households. Though our interest is in 𝑓𝑅 ,

9
above conditions also allow 𝑐𝑅 and 𝑔𝑅 to vary across R.

The optimization problems (2) through (4) lead to the Lagrangian function ℒ𝑅 ,

ℒ𝑅 = 𝑈[𝑓𝑅 (𝐾𝑅 ; 𝐴) − 𝑐𝑅 (𝑤, 𝐾𝑅 )] + 𝜆𝑅 ⋅ 𝑔𝑅 (𝐾𝑅 , 𝐴, 𝑤, 𝜂), ∀𝑅. (5)

where 𝜆𝑅 is the Lagrange multiplier. Given (4) and the nonnegativity constraints of 𝐾𝑅 , the

optimal solutions 𝐾𝑅∗ (asterisks indicate the solution values hereafter) satisfy the following Kuhn-

Tucker conditions for each R; (i) 𝜕ℒ𝑅∗ /𝜕𝐾𝑅 ≤ 0, (ii) 𝐾𝑅∗ (𝜕ℒ𝑅∗ /𝜕𝐾𝑅 ) = 0, (iii) 𝐾𝑅∗ ≥ 0, (iv)

𝜕ℒ𝑅∗ /𝜕𝜆𝑅 ≥ 0, (v) 𝜆∗𝑅 (𝜕ℒ𝑅∗ /𝜕𝜆𝑅 ) = 0, and (vi) 𝜆∗𝑅 ≥ 0, where the negative sign in (i) holds if

𝐾𝑅∗ = 0. 𝐾𝑅∗ satisfies the above Kuhn-Tucker conditions for each R. The farmer chooses R* = 1 if

𝑈|𝑅∗=1 ≥ 𝑈|𝑅∗=0 given 𝐾𝑅∗ and vice versa.

The Kuhn-Tucker conditions depend on 𝑓𝑅 , 𝑐𝑅 , 𝑔𝑅 , 𝐴, 𝑤, and 𝜂. Parameters defining 𝑓𝑅 ,

𝑐𝑅 and 𝑔𝑅 are also functions of exogenous variables 𝐴, 𝑤, 𝜂. Our empirical models therefore are

the following reduced form equations;

𝑅 ∗ = 𝑟(𝑓𝑅 , 𝑐𝑅 , 𝑔𝑅 , 𝐴, 𝑤, 𝜂) = 𝑟(𝐴, 𝑤, 𝜂) (6)

𝐾𝑅∗ = 𝑘(𝑓𝑅 , 𝑐𝑅 , 𝑔𝑅 , 𝐴, 𝑤, 𝜂, 𝑅 ∗ ) = 𝑘(𝐴, 𝑤, 𝜂, 𝑅 ∗ ) (7)

where r and k are functions. 𝑌𝑅∗ is related to 𝐾𝑅∗ through structural equation 𝑓𝑅 , so that,

𝑌𝑅∗ = 𝑓𝑅 (𝐾𝑅∗ ; 𝐴, 𝑅 ∗ ). (8)

3.2. Estimation procedures

Our empirical approach is to estimate 𝑓𝑅 and corresponding RTS, 𝜌𝑅 , for each R given

the observed 𝑌𝑅∗ , 𝑅 ∗ , 𝐾𝑅∗ , 𝐴, w and 𝜂. If 𝜌1 > 𝜌0 conditional on exogenous variables 𝐴, 𝑤, and 𝜂,

then we interpret that the HTS increases the RTS. However, if the RTS increases due to other

factors and HTS is simply a response to such an increase, then we expect to find 𝜌1 = 𝜌0

conditional on 𝐴, 𝑤, and 𝜂. While some studies assess the impact of R* on the production

10
function parameters by adding the interaction terms between R* and input variables (Wan and

Cheng, 2001), we depart from such approach to address potential endogeneity problems

associated, as described below.

Consistently estimating 𝑓𝑅 (and 𝜌𝑅 ) requires addressing two sources of endogeneity

associated with (6) through (8). First, a non-zero correlation between idiosyncratic error terms in

(6) and (8) causes the sample selection problem. Second, 𝐾𝑅∗ can be correlated with idiosyncratic

error terms in (8). Both lead to endogeneity problems in (8).

Several sample selection models address the first type of endogeneity, including

switching regression model (SR) (Goldfeld and Quandt, 1976; Maddala, 1983), and inverse

probability weighting model (IPW) (Horvitz and Thompson, 1952; Wooldridge, 2007). For

impact evaluation in the agricultural sector, IPW is applied to the estimation of the average

treatment effects (ATE) (for example Cunguara and Moder, 2011), or the effect on production

function (Cavatassi et al., 2011). However, production function in Cavatassi et al. (2011) treats

all variables as exogenous.

Generalized method of moments (GMM) (Hansen, 1982) has long been used to address

the second type of endogeneity issues. Compared to other instrumental variable (IV) approaches

like the two-stage least squares, GMM is more efficient in the presence of heteroskedasticity,

including serial correlation of error terms, which is common in agriculture due to locally

correlated production environments.

The literature addressing both types of endogeneity is relatively thin. Recent studies

modify the SR by incorporating the potential endogeneity in the second stage equations

(Bellemare and Barrett, 2006; Takeshima and Winter-Nelson, 2012). Their specifications

provide a tool to estimate the effect of R* on 𝜌𝑅 even when the estimation of 𝑓𝑅 involves

11
endogeneity. However, SR usually does not fully address the issue of the comparability between

treatment and control groups, in the same way as IPW does. Also, SR is susceptible to the

multicollinearity problem between Inverse Mills Ratio (IMR) and the other exogenous variables

(Puhani, 2000). Therefore, an additional empirical method needs to complement the SR.

We do so through IPW-GMM. Under the assumption of conditional independence

(ignorability), GMM weighted by the inverse of the probability is consistent on the subsample of

responding units (Nicoletti, 2006). Recent studies extend this approach to obtain consistent

GMM estimates when samples are non-randomly selected (Abowd et al., 2001; Chen et al.,

2008). We contribute to the literature by exploiting the fact that IPW-GMM is a useful tool to

estimate the case like ours in which the effect of an endogenous treatment on endogenous

production function parameters is of interest.

We estimate (6), (7) and (8) with IPW- and SR-GMM. For both methods, we first

estimate (6) with a Probit model,

𝑍𝛾
Probability(𝑅 ∗ = 1|𝑍) = 𝑝̂ = Φ(𝑍𝛾) = ∫−∞ 𝜙(𝑣)𝑑𝑣 (9)

where Z = A, w and 𝜂. 𝑝̂ is the predicted propensity of HTS, and 𝛾 is a set of parameters to be

estimated. Φ is the standard normal distribution function, while 𝜙 and 𝑣 are the standard normal

density function and its element.

We then estimate 𝑓𝑅 (8) separately for TS-hirers and non-hirers as,

ln 𝑌 = 𝛽0 + ∑𝑖 𝛽𝑖 ln 𝐾𝑖 + (1/2) ∑𝑖 ∑𝑗 𝛽𝑖𝑗 ln 𝐾𝑖 ln 𝐾𝑗 + 𝛽𝐴 𝐴 + 𝜀 (10)

in which 𝛽’s are parameters to be estimated (with corresponding subscripts), and 𝜀 is the

idiosyncratic error terms, and i, j = chemical fertilizer in nutrient, family labor (adult male, adult

female, child), hired labor, land area cultivated, irrigation, agricultural capital and other cash

̂𝑅 = ∑𝑖(𝜕 ln 𝑌 /𝜕 ln 𝐾𝑖 ) = ∑𝑖 𝛽̂𝑖 +
expenses (which includes expenses on HTS). Then 𝜌

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∑𝑖[(𝛽̂𝑖𝑖 + ∑𝑗≠𝑖 𝛽̂𝑖𝑗 ) ln 𝐾𝑖 ] (Kim, 1992).

The assumption of 𝛽𝑖𝑗 = 0 reduces (10) from Translog to Cobb-Douglas specification.

There are trade-offs between these specifications. The Cobb-Douglas specification provides

reasonable estimates of production function parameters when samples are small and endogeneity

of multiple 𝐾𝑗 must be addressed, but it forces the elasticity of substitution between all 𝐾𝑗 to be

one, and forces the RTS to be the same across all agents. The Translog specification drops these

restrictions, but often complicates the endogeneity of multiple 𝐾𝑗 , and leads to inefficient

estimates if multicollinearity is severe (In our case, doing so in Translog specification involves

52 endogenous variables, and may lead to unreliable estimates.). This is especially true when, as

is described in the later section, the sample size is kept small to ensure comparability of TS-

hirers and nonhirers. We therefore estimate both specifications (Translog forms are estimated

treating all 𝐾𝑗 as exogenous). Unlike in the Cobb-Douglas specification, 𝜌

̂𝑅 vary across

observations in the Translog specification. In the Translog specification, we focus on the IPW

sample medians of 𝜌
̂,
𝑅 as they are likely to be both representative and robust against potential

outliers in 𝜌
̂.
𝑅 In the results section, we show that the evidence is robust to the choice of

specification.

The estimation approaches for (10) differ between IPW-GMM and SR-GMM. IPW-

GMM estimators for TS-hirers are,

′ ′
𝛽̂ = arg min[𝐸(𝑚/√𝑝̂ )] 𝑊
̂ [𝐸(𝑚/√𝑝̂ )] (11)
𝛽

and those for non-hirers are,

′ ′
𝛽̂ = arg min[𝐸(𝑚/(√1 − 𝑝̂ ))] 𝑊
̂ [𝐸(𝑚/(√1 − 𝑝̂ ))] (12)
𝛽

̂ is the suitable weighting matrix estimated in

where 𝐸 is the expectation over samples and 𝑊

13
GMM. Weights are the inverse of “square root” of the propensity scores, because the weights

apply to the objective function that is a square of the moment conditions. 𝑚(⋅) is the moment

condition,

𝑚 = 𝑍′[ln 𝑌 − (𝛽0 + ∑𝑖 𝛽𝑖 ln 𝐾𝑖 + (1/2) ∑𝑖 ∑𝑗 𝛽𝑖𝑗 ln 𝐾𝑖 ln 𝐾𝑗 + 𝛽𝐴 𝐴)]. (13)

IPW-GMM is “doubly-robust” (Robins and Rotnitzky, 1995); the overall model is consistent as

long as either the model of the propensity score 𝑝̂ , or the model of the production function is

consistent, even when the other model is misspecified.

In SR-GMM, we first construct IMR for TS-hirers (𝜔1 = 𝜙(𝑍𝛾̂)/Φ(𝑍𝛾̂)) and non-hirers

(𝜔0 = −𝜙(𝑍𝛾̂)/[1 − Φ(𝑍𝛾̂)]) from (9). We then estimate 𝑓𝑅 for TS-hirers and non-hirers using

GMM, removing √𝑝̂ and √1 − 𝑝̂ from (11) and (12), while adding 𝜔
̂𝑅 to A in (13).

While some studies using SR jointly estimate the selection equation and the main

equation, we estimate them in two steps because the joint estimation is more complicated due to

the endogeneity in the main equation. In addition, unlike the joint estimation method, our two-

step estimation does not require the assumption that idiosyncratic errors in the main equation are

normally identically distributed. This is appropriate when idiosyncratic errors are serially

correlated within the locality or heteroskedastic, as is often the case in the agricultural sector.

3.3. Other specification issues

Our analyses are based on the cross-section data as described in the next section.

Although panel samples can be constructed with earlier rounds of the survey, the sample size is

small, particularly after extracting comparable samples among TS-hirers and non-hirers, and

preventing us from getting reliable results. In addition, various scholars note that the RTS is a

long-run rather than a short-run concept, and cross-section data (with methods addressing

14
endogeneity) may be more appropriate than fixed effects and first difference models which are

more suitable for capturing short-run effects (Basu, 2008; Sheng et al., 2015; Gollin et al., 2016).

Arguably the primary difference between cross-sectional specification and typical panel

specification with fixed effects is that the former focuses on the environment where various

factors that do not change in the short-run (for example, land endowments, demographics as well

as unobserved individual specific effects including ability or management skills) change over

time, and considers each cross-sectional household as a hypothetical state which a certain

household can evolve to in the long-run. While the virtue of a panel data specification is to

isolate unobserved fixed effects that are correlated with exogenous variables, and the absence of

such mechanism in cross sectional specification leads to potential endogeneity, our specifications

of IPW and GMM partly address it.

Standard errors for our estimators are adjusted accounting for the fact that 𝑝̂ is an

estimated variable. Unlike standard SR or IPW, our specification involves endogenous variables

in the second stage regressions. To our knowledge, the formulas of standard errors for this type

of estimators have not been developed in the literature. We therefore use paired bootstrap (Efron,

1979); we repeat 100 times the entire estimation procedures using randomly resampled data, and

use the standard deviations of bootstrapped coefficients as finite estimates of standard errors for

each parameter. Resampling is conducted treating the enumeration areas (EAs), described in the

next section, as clusters so that the estimated standard errors reflect the potential serial

correlation in idiosyncratic shocks within EAs.

4. Data and variables

The NLSS 2010 were collected through two-stage stratified random sampling methods

15
(Nepal CBS, 2011). First, the country was divided into 14 strata across three agro-ecological

belts, Terai, Hills and Mountains. They consist of 3 urban strata (urban areas in the Terai, Hills

outside Kathmandu valley, and Kathmandu Valley), 10 rural strata from Terai and Hills (5

developing regions each; Eastern, Central, Western, Mid-western and Far-western), and

Mountains. Second, a total of 500 EAs were randomly selected, with a pre-determined number of

EAs within each stratum (Nepal CBS, 2011, Box 1.2). Then, 12 households were randomly

selected from each EA. In addition, NLSS 2010 randomly surveyed 12 households each from

100 EAs randomly selected from the second round of NLSS (NLSS, 2003). In total, the NLSS

2010 interviewed 7200 households (Nepal CBS, 2011, Box 1.3). 2856 are the primary sample for

the Terai, among which 1965 are farm households, reporting the cultivation of some plots. As is

described in 4.2, we focus on the subset 600 of this sample that satisfies good overlap properties,

and later check the robustness of results against this subsampling. Other sources of data used to

construct key agroecological variables are described in Appendix A.

4.1. Variables

Variables used as determinants of HTS, output and inputs in the agricultural production

function, and IVs for endogenous inputs variables, are selected and constructed based on the

relevant literature. These variables capture technological, economic, and biophysical resource

endowment of the households. Due to the space limitation, definitions and how these variables

are constructed are provided in the Appendix A. All monetary values are deflated by average

local prices of rice and wheat, which are the most commonly consumed staples in Nepal, to

control for the potential variations in price index across space. Throughout the paper, when

variables are transformed into the natural log form, the values of 0.0001 were added so that zero

16
values can also be transformed into the natural log. We also estimate the models using 0.01

instead of 0.0001, and find that the results are robust. Similar approaches are used in various

studies (see Jacoby, 1993, and Michalopoulos and Papaioannou, 2014, for example).

4.2. Sample constructions and overlap properties

Having comparable samples of TS-hirers and nonhirers (good overlap properties) is

important for IPW (Busso et al., 2014). Overlap properties are poor when the covariate

distributions are substantially different between the two groups (Imbens and Wooldridge, 2009).

We therefore select the subset of samples based on several exogenous criteria. First, we limit the

samples to Terai, and exclude those in the Hills or Mountains where agro-ecological

characteristics are very different. Samples are also limited to the households that own draft

animals (bullock, cow, buffalo, horse, donkey, mule), because owning draft animals may

significantly affect the use of animal traction that can substitute the HTS. As was mentioned

above, tractor owners are also excluded.

We also limit the samples to the village district committees (VDCs), Nepal’s

administrative units below districts, where at least 20% of the samples are TS-hirers, and at least

10% are nonhirers, so that 𝑝̂ may be distributed away from 0 and 1, a key overlap condition

(Busso et al., 2014). We also exclude households whose heads have at least 12 years of formal

education, are located in areas with terrain ruggedness index greater than 300, without assets

(other than farmland, agricultural capital, livestock), or with such assets worth more than 30,000

kg of cereals evaluated at local cereal prices. After these procedures as well as dropping

observations with missing values, the total samples were reduced to 600.

Robustness of results against these selections is conducted as described in Appendix C.

17
We find that main results are robust when the analyses include all samples. However, those

samples lead to poorer overlap properties, indicating that our primary sample leads to more

consistent and reliable estimates.

As was mentioned earlier, we also exclude tractor owners from the analysis. Tractor-

owner farm households in our sample differ considerably from non-owner farm households,

particularly in financial endowments (Takeshima et al., 2015b). Combining them with non-

owner farm households in estimating production function imposes strong assumptions that

tractor-owner farm households have the same production function structure as non-owner farm

households. Tractor owners are also few in our sample relative to nonowner farm households,

preventing us from testing a separate hypothesis that tractor ownership affects the RTS.

4.3. Descriptive statistics

Table A3 in online Appendix A summarizes the mean values of each variable used in the

analysis. It shows the descriptive statistics with and without weights which are estimated in the

next section, because it demonstrates how the IPW process improves the matching properties of

the samples. While sample means of exogenous variables are relatively similar across TS-hirers

and non-hirers without weights, they are still statistically significantly different across groups for

several variables. However, with weights, the differences become statistically insignificant for

most exogenous variables. Meanwhile, mean values of endogenous variables are still statistically

significantly different between two groups even after the weighting.

The IPW procedure therefore effectively reduces the differences between two groups in

our sample, so that any differences in production behaviors are more reliably attributed to HTS

rather than the differences in other observed characteristics. Descriptive statistics in Table A3

18
therefore further motivate our empirical analyses.

5. Empirical results

We first briefly discuss the determinants of the propensity of HTS, 𝑝̂ . We then discuss

more in detail the estimated production functions, RTS, and robustness of results under various

alternative specifications.

5.1. Propensity of hiring in tractor services

Estimation results of Probit regression in the first stage is summarized in Table B1 in

Appendix B. It is important to note that Probit results in Table B1 are applicable only within a

narrowly defined population as described in section 4.2, and should not be generalized to the

broader farm population of Nepal. For example, 𝑝̂ is generally unaffected by factors like more

widespread presence of tractor owners within VDCs in the sample, or the wages. This is possibly

because our sample is limited to the Terai with relatively well integrated labor market (Maystadt

et al., 2014) that reduces wage variations across locations, and to VDCs with at least 20% of the

sample are TS-hirers.

𝑝̂ is higher if the household is located in areas with the smoother terrain, has a more

educated household head. 𝑝̂ is higher for households with fewer male members, possibly

reflecting the demand for TS to substitute family labor shortage. 𝑝̂ is higher the closer the nearest

ARS is, possibly reflecting the positive roles of agricultural extension or improved varieties. 𝑝̂ is

higher if DAP fertilizer price is higher, possibly indicating the substitution effect between

mechanization and more land saving factors like fertilizer. 𝑝̂ is also higher in areas more distant

from the nearest market center. This might be because these areas may be more sparsely

19
populated with greater land-to-labor ratios. For example, in Ghana, Benin (2015) shows that the

potential for mechanization expansion can be greater in those areas if tractor service providers

are present.

The distributions of 𝑝̂ are illustrated in the left panel of Figure 1. For comparison, the

right panel of Figure 1 illustrates 𝑝̂ obtained from the full sample. Compared to the right panel in

which a substantial mass of propensity scores are distributed around 0 or 1, the two samples of

TS-hirers and non-hirers in the left panel have a fairly good overlap without concentrations of 𝑝̂

around 0 or 1. Such good overlap can ensure IPW-estimators to be reliable (Busso et al., 2014).

5.2. Production function and returns to scale

Table 1 summarizes the estimated Cobb-Douglas production function parameters,

differentiated by the TS-hiring status, and specifications used (due to space limitations,

coefficients on other variables are not shown). Hausman test (1978) rejects the null hypothesis

that input variables are jointly exogenous, justifying our choice of GMM over OLS. All models

satisfy strong identifications and orthogonality conditions, based on Kleibergen-Paap (2006) rk

Wald statistics, and Hansen J-statistics (Hansen, 1982).

[Insert Table 1 here]

̂),
The estimated RTSs (𝜌𝑅 our main interests, are statistically significantly higher among

TS-hirers (around 0.9) than among nonhirers (around 0.6 ~ 0.7), consistent with the hypothesis

that HTS is causing an increase in RTS. The difference in RTS may be driven by the output

elasticity (the estimated coefficient) of area cultivated, and to a lesser extent that of agricultural

20
capital, while that of labor is generally higher among non-hirers (albeit marginally). While

endogeneity is suggested, estimated patterns are qualitatively similar between OLS and GMM. In

the SR-GMM, the coefficients on IMR are statistically insignificant. Also, the results between

GMM and IPW-GMM are generally fairly similar. Endogeneity due to self-selection may be

therefore relatively limited in our sample. In any case, the evidence that HTS is causing an

increase in RTS is strong and robust for the samples at hand.

The relative magnitudes of estimated output elasticities are generally consistent with the

previous studies. For both TS-hirers and nonhirers, the area cultivated exhibits the highest output

elasticities among all factors, consistent with previous studies on Nepal (Abdulai and Regmi,

2000; Devkota and Upadhyay, 2013). Relatively high output elasticities for agricultural capital

are consistent as well with Devkota and Upadhyay (2013). Low or slightly negative output

elasticity of labor tends to be observed in environments with surplus labor (Wan and Cheng,

2001), which might apply to Terai of Nepal, experiencing excessive labor in-migrations in recent

years (Maystadt et al., 2014). This is contrasting to estimates in Africa (for example, Adesina

and Djato, 1997), where labor is relatively scarcer than land.

The implications on RTS are similar in Translog specifications. Table 2 presents the

estimated RTS evaluated at the IPW-sample medians, while estimated individual coefficients are

shown in the Appendix B (Tables B2 through B7). First, full Translog specifications lead to

magnitudes of RTS generally similar to the Cobb-Douglas specification (0.9 ~ 1.0 for TS hirers

and 0.7 for nonhirers) although, due to higher standard errors, the difference in RTS is somewhat

imprecise with p-values of 0.13 and 0.154 (insignificant at 10% level). To obtain more precise

results, we use the findings that all interactive terms containing family labor are jointly

insignificant for TS-hirers (p-value = .614 and .722). We re-estimate for TS-hirers a restricted

21
Translog function in which all interactive terms containing family labor are excluded. This

reduces the standard errors of estimated RTS (from .139 to .085 in SR-GMM and .130 to .083 in

IPW-GMM). The difference in RTS is statistically significant at 10% (p-value = .075 and .097)

with this specification.

[Insert Table 2 here]

The F-test rejects the Cobb-Douglas specification in favor of the Translog specification

(p-value = .000). However, this is only suggestive because the exact test must take into account

the endogeneity of input variables, which cannot be feasibly incorporated in the Translog

specification as discussed above. The implication is that the effects on RTS may vary across

households, and future studies need to examine such heterogeneity more closely.

5.3. Other robustness checks

We further conducted robustness checks (Appendix C provides the detail). Our results are

found unlikely to be driven by (a) price index used to convert all monetary terms into real terms;

(b) samples constructed; (c) the distinction of permanently hired labor from temporarily hired

labor; nor (d) other potential sources like specialization or differential access to improved

varieties. Our results are also unlikely to be driven by the effects of other endogenous inputs uses

that happen to be highly correlated with HTS.

IPW relies on the “ignorability” assumption, which is also called “selection-on-

observables” or “unconfoundedness” (Wooldridge, 2007). The robustness check also suggests

that our results are likely to be robust against the small changes in 𝑝̂ due to the violation of

22
ignorability assumption. However, to our knowledge, no formal procedure has been developed to

check the robustness of IPW-GMM estimates against the violation of ignorability assumption.

Future studies must conduct a more formal investigation of this issue.

6. Conclusions

The RTS is one of the important properties of production technologies. Agricultural

transformation around the world has often accompanied the increase in the RTS, and may also be

an important process for similar transformations in low-income countries. Despite such

importance, literature is thin on the direct causes of changes in agricultural RTS. We attempted

to fill this knowledge gap. We found that HTS significantly increased the RTS among some

Nepal Terai farm households. We did so by jointly addressing two forms of endogeneity; the

endogeneity in decisions to hire in tractor services, and in decisions on inputs use in production

functions.

These findings enrich our understandings of the role of agricultural mechanization,

particularly mechanization supplied through custom-hiring. Also, it raises some important new

questions for the future studies regarding the technology adoption, such as the choice of

technologies in the face of not only the relative marginal profitability, but also the differing

effects on the returns to scale.

As a policy recommendation, further research should be conducted in Nepal to

understand better the implications of the findings. Promoting HTS may shift the comparative

advantage in agricultural production to more land and capital-endowed households, rather than

less-endowed households. Further research should be conducted to assess how these less land

and capital-endowed households are affected by the mechanization growths through own HTS

23
and HTS by more land and capital-endowed households.

Lastly, there are also limitations to our analysis. The chief limitation of our analysis is

that, due to the data limitation, it does not investigate the effect of tractor ownership and their

service provisions on the RTS, which is potentially one of the substantial sources of the growth

of RTS in agriculture. Such data limitation arises because tractor-owning farm households,

despite such potential importance, tend to account for a small share of the population and their

sample sizes tend to remain too small in nationally representative household surveys like NLSS.

Future studies should investigate such effect of tractor ownership on the RTS, using specially

designed surveys which properly stratify the sample framework so that information is collected

for a sufficient number of tractor owning farm households with characteristics that are

comparable to those of nonowners, as well as panel data collected over sufficiently long time-

span of new tractor owners, which can offer critical insights into the process of the change in

RTS. With such data, our methodology can be extended to investigate the effect of tractor

ownership on the RTS.

Similarly, our results apply only to a segment of tractor service-hirers whose suitable

counterfactuals can be found among the nonhirers. Our findings may not be readily extended to

households whose characteristics differ considerably from those studied here. In addition, we can

conduct only informal analysis on the robustness of the results against the possible violation of

ignorability assumption inherent in IPW-GMM. Future studies need to address these issues to

obtain more robust inference.

24
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Table 1. Production functions by tractor hiring status among non-tractor-owners under various econometric methods

Variables Model / samples

Un-weighted IPW-OLS GMM SR-GMM IPW-GMM

OLS

TS- Non- TS- Non- TS- Non- TS- Non- TS- Non-

hirers hirers hirers hirers hirers hirers hirers hirers hirers hirers

ln (Fertilizer nutrient)b -.009 -.016 -.010 -.018 .002 -.016 .000 -.014 .013 -.016

(.017) (.014) (.024) (.014) (.027) (.016) (.046) (.026) (.043) (.024)

ln (adult male family labor)b -.006 .014* -.006 .013 -.003 .003 -.002 .012 -.004 .004

(.007) (.008) (.009) (.009) (.005) (.009) (.011) (.014) (.011) (.013)

ln (adult female family labor)b -.026** .024*** -.028** .026*** -.015 .060*** -.014 .062*** -.023 .063***

(.011) (.008) (.014) (.010) (.013) (.007) (.025) (.018) (.024) (.017)

ln (child family labor)b .007 .001 .007 .000 .019*** .019*** .019* .018* .016* .019**

(.006) (.006) (.007) (.007) (.006) (.006) (.010) (.010) (.010) (.009)

ln (hired labor)b -.007 .001 -.008 .000 -.010 -.015* -.010 -.020 -.012 -.014

(.006) (.008) (.008) (.009) (.009) (.009) (.014) (.019) (.012) (.019)

30
ln (area cultivated)b .450*** .238*** .463*** .231*** .529*** .397*** .519*** .378*** .564*** .382***

(.064) (.065) (.077) (.077) (.058) (.061) (.132) (.117) (.125) (.116)

ln (irrigation (= 1 if used .006 .029*** .005 .028*** .009 .016 .010 .015 .002 .015

irrigation))b (.007) (.008) (.008) (.009) (.008) (.012) (.015) (.020) (.015) (.019)

ln (agricultural capital) .309*** .262*** .299*** .298*** .291*** .161** .281*** .123 .305*** .168*

(.059) (.075) (.060) (.074) (.055) (.064) (.078) (.094) (.082) (.092)

ln (other cash expenditure) .164*** .045** .157** .042* .092 .084*** .095 .097** .071 .091**

(.053) (.020) (.067) (.024) (.064) (.024) (.125) (.040) (.119) (.039)

IMR -.138 -.532

(.223) (.341)

̂)
Estimated RTS (𝜌𝑅 .888*** .597*** .878*** .620*** .914*** .709*** .898*** .671*** .933*** .712***

(.065) (.069) (.073) (.071) (.056) (.061) (.097) (.098) (.094) (.093)

p-value

H0 = covariates jointly .000 .000 .000 .000 .000 .000 .000 .000 .000 .000

insignificant

H0 = no endogeneityc .036 .000 .053 .000 .033 .000

31
 H0 = weakly identifiedd .000 .000 .000 .000 .000 .000

H0 = not over-identifiede .123 .665 .137 .644 .141 .763

H0 = returns to scale are equal .000 .011 .013 .099 .095

Number of observations 291 309 291 309 291 309 291 309 291 309

Source: Author. Asterisks indicate the statistical significance; *** 1%, ** 5%, * 10%.

Numbers in parentheses are estimated standard errors.

a
Other variables include various household characteristics, agroecological characteristics, soil dummies, administrative fixed effects,

described in Appendix A, and intercept. bPotentially endogenous variables. cBased on Hausman test (Hausman, 1978). dBased on

Kleibergen and Paap (2006) rk Wald statistics. eBased on Hansen J-statistics (Hansen, 1982).

32
Table 2. Robustness check on the differences in RTS based on Translog production

functions estimated through IPW-OLS

SR-GMM IPW-GMM

TS-hirers Nonhirers TS-hirers Nonhirers

Translog Restricted Translog Translog Restricted Translog

translogb translogb
a
̂)
Estimated RTS (𝜌𝑅 .991 .977* .702 .998 .979* .723

(standard errors) (.131) (.095) (.123) (.139) (.085) (.116)

p-value: (H0: labor .722 .002 .614 .005

interaction variables

jointly insignificant)

p-value: (H0: 𝜌
̂𝑅 not .106 .077 .130 .075

different from that of

nonhireres)

Source: Author. Asterisks indicate the statistically significant difference from the estimate

for non-hirers.; * 10%.

a
Figures are inverse probability weighted sample median.
b
“Restricted translog” drops all interactive terms that contain family labor variables.

33
 2.5

2
2

1.5
1.5
Density

Density

1
1

.5
.5
0

0 .2 .4 .6 .8 1 0 0 .2 .4 .6 .8 1
propensity score propensity score

tractor service hirers tractor service hirers

non-hirers non-hirers
kernel = epanechnikov, bandwidth = 0.0448 kernel = epanechnikov, bandwidth = 0.0514

Figure 1. Kernel density estimations of propensity scores 𝑝̂ (left = matched samples; right = raw

samples)

Source: Author.

34

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