The analysis of irreversibility, uncertainty and dynamic technical inefficiency on the investment decision in the Spanish olive sector

Abstract

This study addresses irreversible investment decision-making in the context of uncertainty when allowing for inefficiency to be transmitted over time. Both irreversibility and persistence in technical inefficiency can lead to sluggish adjustment of quasi-fixed factors of production. The context of our application is the Spanish olive sector using farm-level data. We first estimate a dynamic stochastic frontier model to determine the long-run technical efficiency and its persistence. Then we address the decision to invest under uncertainty and irreversibility using a real option approach and include the technical inefficiency and its persistence in the simulation model to evaluate their impact in the investment decision. Technical efficiency in the dynamic model is 72.7 per cent, which is 5.5 per cent lower than the static framework suggests. We find that olive grove investment is irreversible. However, the level of persistence in technical inefficiency is fairly low, suggesting that efforts to mitigate price uncertainty can improve production returns to the Spanish olive sector.