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Drying and Milling Cost Functions of Paddy: Empirical Estimates for

Government Processing Complexes in Malaysia

Article · June 1988


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3 authors, including:

Azman Hassan
Universiti Putra Malaysia


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Pertanika 11(2), 283-288 (1988)

Drying and Milling Cost Functions of Paddy: Empirical Estimates

for Government Processing Complexes in Malaysia
Faculty ofEconomics and Management
Universiti Pertanian Malaysia
43400 Serdang, Selangor, Malaysia

Keywords: Paddy/rice processing; government mills; drying cost functions; milling cost functions; cost

Kajian ini menggunakan kaedah fungsi kos statistik untuk model kos pengeringan dan pengilangan
bagi kilang-kilang padi kerajaan di Malaysia. Fungsi-fungsi kuadratik dan songsang dianggarkan. Hasil
daripada kajian ini menunjukkan bahawa skala ekonomi wujud dalam pengeringan dan pengilangan.
Kos ekonomi dicapai pada paras output yang tinggi. Seterusnya kajian yang lebih terperinci terhadap data
kos dan output menunjukkan bahawa kebanyakan kilang padi kerajaan beroperasi pada tingkat kuantiti
yang kebanyakan kos ekonomi tidak dipergunakan.

In this paper, the statistical cost function approach was used to model the drying and milling cost
for government paddy/rice processing complexes in Malaysia. The quadratic and inverse cost [unctions
were estimated. The results suggest that there exists cost economies at relatively high output levels for
both the drying and milling operations. Examination of output data indicates that a large number of
government paddy mills operate at low outputs, with cost economies unexploited.

INTRODUCTION postharvest industry. Rising input cost and stag-

nating output price have placed a squeeze on
Over the years, paddy processing in Malaysia has privates millers' margin. Various government
been increasingly taken over by the government. programmes, notably the price control on rice,
In 1983, capacity utilization by private millers has adversly affected millers' activities. At the
was at 33 percent whereas the governn:tent mills same time, the high capital investment required
utilized more than 80 percent of their available to enter the postharvest industry effectively
capacity (National Paddy and Rice Board, 1984). discourages new entrants.
The increasing role of the government complexes If the present trend continues, with no
can be attributed to the present paddy pricing significant changes to the paddy and rice pricing
system and the closure of many private processing system, it is likely that there will be a further
plants in recent years. During the 1981-83, 25 increase in the role to be played by government
private rice mills were reported to have closed complexes in paddy processing. Already calls to
down (National Paddy and Rice Board, 1984) increase the number of government mills and
because of low profit margins. complaints concerning the inadequacy of the
The shutdown of many private mills is present government paddy procurement system
symptomatic of adjustments within the paddy are being raisell by various quarters. The irnpli-

cations of setting up more government mills are serious problem on pragmatic grounds and also,
tremendous in terms of cost. 1 if the objective of estimating the cost function
This paper reports a study on the cost is to estimate expected cost functions instead of
efficiency of government rice processing mills. certain cost functions from perfect technological
While industrial organization theory suggests frontiers (Heady, 1956; and Walters, 1960, Wal-
that private firms are either cost minimizers ters, 1963, Bhati, 1974).
or profit maximizers, the objective of govern- Statistical cost analysis essentially involves
ment statutory bodies may be quite different. the examination of the relationship between the
With regard to government mills, there is no cost of producing some output and the size or
written information available as to how they level of the output produced. Economic theory
should be operated. It is, however, generally suggests that for any firm of a given size, its cost
understood that complex managers are expected per unit of output (AC) curve in the short run will
to minimise monetary losses. Given the current be U-shaped. As the firm increases its capacity or
government paddy purchasing policies and rice size in the long run, there will be short-run average
price, it would not be possible for these complexes cost curves (SACs) for each size (Figure 1). A
to generate any profit. Unfortunately, published curve enveloping the SACs from below in the
work in the area of cost efficiency of government manner shown in Figure 1, is the long-run average
mills are scanty. Runte and Ali (1973) provided cost curve (LAC). LAC therefore represents the
an economic evaluation of drying units in the cost-size relationship. LAC initially declines due
country, while Fredericks and Wells (1983) to internal physical and pecuniary economies of
considered the technical and economic aspects scale occurring as the fum size increases. The fum
of rice processing in Malaysia. In both studies, whose SAC's lowest point coincides with the
cost analysis was given scanty treatment. An lowest point on the LAC operates at the optimum
earlier paper on the same topic (Ghaffar and size according to the minimum per unit cost of
Hassan, 1985), provided some preliminary esti- production criterion. When the size of firms
mates of costs associated with rice drying and increases beyond the optimum size, internal dis-
milling in Peninsular Malaysia. Although this economies set in and as a result the LAC takes an
particular study suffers from several drawbacks, upward turn. Thus in short, the internal economies
notably the small number of observations used and diseconomies give rise to the U-shape of LAC.
for the computation of costs, it nevertheless
provides a general idea of cost patterns within
government rice mills. Items such as fuel, elec-
A vcrage COSt
tricity and labour make up a good portion of the per unit of
total operation cost. Administrative overhead output

contributes the largest portion to total operation


Modelling, Drying and Milling Cost Relationships LAC

The approach used in this study is the statistical

cost function approach. One generally accepted
drawback of this approach was outlined by Fried-
man (1955) and is now commonly known as the
"~egression fallacy". However, several researchers Fig. 1.' Hypothetical shortrun and longrun Average
are of the opinion that regression fallacy is not a Cost Curves

1A study conducted by LPN indicates that if the trend in shut down of private rice processing plants
continues, the government would have to build at least 66 more processing plants which would cost the govern-
ment over 1 billion ringgits (NPRB, 1984).

284 PERTANlKA VOL. 11 NO.2, 1988


In many studies on average cost relationship, (Ghaffar and Hassan, 1985). For milling output,
the following functional forms have been used the quantity of rice produced was used.
widely (e.g. Barthwal and Nair, 1979; Bhati, 1974; As the processing complexes were built in
and McLemore et al. 1983). different years, they were stratified into four
phases according to the year the complexes were
AC = a + {3 Q + [j Q2 + U (1) commissioned. These time periods were defmed
AC = a + (3(1/Q) + [j (1/Q)2. + V (2) by LPN to reflect technological change. Phase I
is for mills commissioned in the pre-war period
Where AC = average cost up to 1971. Phase II covers 1972 to 1973 while
Q = level of output or throughput Phase III is for the period from 1974 to 1982.
u, v = random error terms Phase IV is for complexes which started operating
from 1983 onwards.. Drying facilities in many of
the complexes in the earlier phases had also been
The linear version of relation (1) is expected to upgraded. This was mainly in the fonn of installa-
give a negative sign for the coefficient of Q and a tion of batch dryers to cater for the peak harves-
positive sign for Q2. This relationship generally ting period. Only 25 of these LPN mills were
leads to an average cost curve that has the U-shape. integrated mills Le. having both drying and milling
Relation (2) is expected to give a positivie sign for facilities.
the coefficient of (1/Q) and a negative sign for Data from all the 31 government mills were
(1/Q)a. This relationship implies that average cost scrutinized to ensure that the data used were
is inversely related to output and that the curve sufficiently accurate. For estimating the milling
declines continously. Log linear version of equa- cost function, data· from eleven mills were exclu-
tion (1), without the Q2 variable, also leads to ded. This is because four of these mills did not
a declining average cost. Such an application in have milling activities while seven others were
existing literature is, however, quite limited. eliminated because many of their figures for
various items were not reported. Seven mills were
Data and Data Collection not included in the estimation of the drying cost
relationship. One mill was eliminated because of
Cross-sectional data on the costs of various output various inconsistencies in coSt and output figures.
and activities of government rice mills were collec- The other six were dropped as many items r~lated
ted by means of specially designed questionnaires to cost and output were not available.
to cover the four processing activities namely:
buying, drying, milling and administration. The
questionnaires have been designed to match the RESULTS AND DISCUSSION
monthly reports submitted by each complex to For the drying cost function estimation, 48 data
LPN Headquarters. Detailed data from all the 31 points were used while for the milling cost func-
government rice mills for 1984 and 1985 were tion estimation, 40 data points were used.
obtained and the costs were grouped into four
As the data used were collected over two
components, namely labour, energy, repairs and
separate years, it is possible that there is the year
maintenance, and other costs. Both drying and
to year effect i.e. the coefficients obtained for
milling operating costs were categorized in the
one particular year may differ substantially from
same manner. These components were then
the ones estimated for the other year. The Chow
aggregated to get estimates of total operating cost test (Chow, 1960) was used to detennine if the
for drying and total operating cost for milling. coefficients of the two regression models for the
As a measure of the throughput, the quan- two separate years were significantly different
tity of continuously dried paddy was used. This from each other. We found no evidence to sU8llest
choice was made as all paddy had to go through that the parameters of the cost functions for the
the continuous drying unit during processing two separate years were significantly different

PERTANIKA VOL. II NO.2, 1988 285


from each other~ Also no attempt was made to where

estimate separate cost functions for different
milling average cost in units of M$l ,000
phases, as intercept dummies used to differen-
tiate phases have coefficients not significantly
MQ =
milling output, in units of 1,000 metric
different from zero. MQ2 = milling output squared
The functional forms for the drying relationship To each of the drying and milling average cost
estimated were: models, a stochastic error term was included addi-
DAC = a + {3DQ + 8DQ2 (3) tively_
DAC = a + (3{l/DQ) + 8 {l/DQ)2 (4) Initial attempts at estimating the average
drying cost function included estimating the log
where linear version of equations (3) and (4) without
DAC = drying average cost in units of M$l,OOO the variables DQ2 and {l/DQ)2 respectively. How-
DQ drying output, in units of 1,000 metric ever, none of these variables yielded coefficients
tons significantly different from zero. The 'best'
DQ2 drying output squared equation for the average drying cost model is as
The functional forms estimated for the milling shown in Table 1. All the estimated coefficients
relationship were: except the intercept term are significant at the
one percent level. The positive sign for the coeffi-
MAc=a+{3MQ+8MQ2 (5) cient of (l/DQ) is consistent with the a priori
MAC = a + {3 (l/MQ) + 8 {l/MQ)2 (6) expectation that average cost declines as output
increases, hence suggesting the presence of size
economies. As for the variable {l/DQ)2, any
TABLE 1 definitive interpretation is not possible. However
Coefficient Estimates of Average Drying Cost Model a
it shOUld have the right sign such that the appro-
priate curvature of the estimated function can be
Coefficient Estimate t-value obtained. The emphirical result indicates that
the curve of the estimated regression is· conti-
nuously declining (Figure 2).
a 3.275 0.859
As in the average drying cost model, various
(3 275.403 4.799 forms of the average milling cost model were also
estimated. The best regression is as shown in Table
8 -507.290 -3.782
2. The results indicate that in general, there is
R2 0.372 support for the negative relationship between
average milling cost with output. The estimated
F 13.601 value of {3 is consistent with a priori expectation.

~he model used was DAC = a + (30/DQ) + 80/DQ)2

2Test of equality of coefficient for different reg- RSS 1 = Residual sum of squares of the regression
ression equations was done using the F-statistic which for the first n/2 observations.
was calculated using the formula
RSS 2 = Residual sum of squares of the second
n/2 observations.
(RSS - L RSS)/k
i=1 n = Number of observations.
F(k, n-k) = 2 ; i = 1,2
L RSS )/( n - 2k) k = Number of estimated parameters.
i =1 The F values obtained were 2.593 and 0.263 for drying
and milling cost models respectively, both not significant
where RSS Residual sum of squares of the regression at 5% level.
fitted to the entire period.

286 PERTANIKA VOL. II NO.2, 1988


milling was computed as -0.649 and -1.054

respectively. 3 These elasticity 'values imply that
a one percent change in output will lead to a
Average cost reduction of 0.65 percent and slightly more than
cost per unit
of oUlpUI one percent reduction in drying and milling cost
respectively. These figures indicate that if output
was to be expanded, cost savings can be achieved
by using existing facilities, as a substantial portion
• • DAC :,. + Hob! + '(..l...Y
• DQ DQ'
of present capacity is not utilized. 4 Examination
" of the cost output data further reveals that the
• minimum cost outputs were about 15,730 1:ons
o ~
Output (thousand tons) for drying and 8,000 tons for milling, respectively.
MSI = USSO.38 (July 1986)
The results indicate that currently, only about 45
percent of optimum drying output, and 52 percent
Fig. 2: Estimated drying Average Cost Curves
of optimum milling output, were produced.

The negative sign obtained for {3 suggests
Coefficient Estimates of Average Milling Cost Model a
the presence of cost economies. That is, there is
a reduction in the average cost as milling output
is increased. The nature of size economies may Coefficient Estimate t-value
be seen further by drawing the actual and esti-
mated cost curves. The actual cost curve appears a 94.198 8.032
to take the typical V-shape (Figure 3).
Since both the underlying cost structures {3 -14.907 -4.112
are characterized by size economies, it is of
interest to consider the extent to which cost 6 0.719 2.906
could be saved if output was to be increased. R2 0.536
This may be achieved by computing the cost
elasticity with respect to output. The elasticity F 21.378
of cost with respect to output for drying and
~he model used was MAC = a + {3MQ + 6 MQ2
cost per unit CONCLUSION
of output
This paper has presented estimates of average cost
'. functions for both drying and milling of paddy,
using data from government owned processing
plants. Although both average and total cost
MAC ~ • +~Q t.MlY.
representations of cost-output behaviour are
theoretically acceptable, empiricial work in
the estimation of cost functions do not seem
OL_:--~'=::::=:;:::::~--15 to indicate any definite preference for either
OutpUI (chousand tons)
one type over the other. In practice, as indicated
MSI = USSO.38 (July 1986) by existing literature, there is a fair mix of the
Fig. 3: Estimated Milling Average Cost Curves two approaches. In some cases the choice of

3These elasticities were computed at the mean.

4 Drying and milling capacities vary among the processing complexes. A study reported by Ghaffar and Hassan
(1985) indicates that drying and milling capacities were 20,000 and 16,000 metric ton per year respectively.
Capacity here was measured with the assumption that each complex runs for 16 hours/day, 200 days a year.
PERTANIKA VOL. 11 NO.2, 1988 287

whether to use average or total cost may not FREDERICKS, L.J. and R.J.G. WELLS (1983): Rice
be obvious. Researchers are often constrained Processing in Malaysia: An Economic and Tech-
by data availability or other estimation problems. nical Analysis. Oxford University Press, Kuala
The results obtained here indicate, however, that
the use of average cost is appropriate for paddy FRIEDMAN, M., (1955): Comments In Conference on
BUsiness Concentration and Price Policy. Princeton
processing. cited in Walters (1963).
To the extent that the results obtained in
this study provide a fair representation of cost- GHAFFAR, R.A. and AZMAN HASSAN, (1985): A
Preliminary investigation of the costs associated
output relationship, some tentative conclusions with rice drying and milling in Peninsular Malaysia,
can be drawn. For both drying and milling opera- In Research and Development Systems and Lin-
tions, cost economies were present. Cost econo- kages for a Viable Grain Post-Harvest Industry in
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long-run average cost for Tennessee Livestock
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288 PERTANIKA VOL. II NO.2, 1988

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