Public Regulation and Production Factor Misallocation. A Restricted Cost Function for the Norwegian Aquaculture Industry

The purpose of this article is to present an analysis of the cost inefficiency of public regulation of input factors. During the data period used here, individual plants within the Norwegian fish farming industry were regulated in their use of production capacity (pen volume) at different size levels. Given the regulation of production capacity, it is likely that farms will be forced to operate off their expansion paths resulting in two types of regulating effects: misallocation of variable input factors (an input misallocation effect), and failure to exploit economics of scale (a scale effect). A restricted cost function, which invokes the assumption of cost minimization given the level of the fixed factor, was specified to measure the effects of regulation on input allocation and on scale economies. The results indicate that variable inputs are more intensively used for farms which are most heavily regulated. Furthermore, in a comparison of results on economies of scale properties estimated by a total long-run cost function with the present restricted cost function, an upward bias of scale economies was indicated for the total cost function approach.