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Rice in Indonesia:Price Policy andComparativeAdvantageIfzal Ali aa Asian Development Bank , ManilaPublished online: 16 Aug 2006.

To cite this article: Ifzal Ali (1987) Rice in Indonesia: Price Policy andComparative Advantage, Bulletin of Indonesian Economic Studies,23:3, 80-99, DOI: 10.1080/00074918712331335271

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RICE IN INDONESIA: PRICE POLICY AND COMPARATIVE ADVANTAGE

Ifzal Alii Asian Development Bank, Manila

Indonesia’s remarkable success in increasing rice production has been achieved through deliberate government intervention. This paper highlights the price policy interventions in the output and input markets for nce. Summary measures of these intervennons are estimated and their impact on private profitability is deter- mined. Economic profitability of paddy and rice production is also estimated for selected regions and these estimates arc used to pinpoint comparative advantage across regionb.

INTRODUCTION

Rice production in Indonesia has grown dramatically at a rate of 6.7% per annum between 1975 and 1985 (Table 1) . This growth, brought about by the introduction of new high-yielding varieties of seed (HYVs), increased fertiliser use and irrigation, has led to yield increases of over 5% per annum: while the area under cultivation has expanded by 1% per annum. As in many other parts of Asia, Indonesia’s remarkable success in raising rice pro- duction has been achieved through deliberate government in- tervention. This paper discusses the economic effects of these interventions in the output and input markets for rice. Its objective is to determine both the private and economic profitability of rice

‘I am thankful to Messrs. 8. Campbell, N.K. Kohh, M. Dowling, J . Roberts, H. Hill and two anonymous referees for very helpful comments on an earher draft. They are in no way responsible for errors that reman. I am gratctul to ME. Y . Azarcon and A. Pardo for competent research assistance. The vie*\ and mterpre- tations m this paper are those of the author and not nrce~sarily those of the Asian Development Bank. The paper was completed in mid-1986, and does not consider the impact of the September 1986 devaluation of the rupiah.

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reference points. These are the nominal protection coefficient on output (NPCO), the nominal protective coefficient on input (NPCI) and the effective protcction coefficient (EPC) (Scandizzo and Bruce 1980). The fourth indicator measuring the impact of market intervention is the nominal protective coefficient on land (NPCL). This is defined as the ratio of the market to economic returns per unit of land.

Each of the four indicators described above provides a useful summary measure of the impact of government intervention. Given intervention in the rice market, for example, we need to deter- mine the profitability of producing rice. Profitability measures are related to investment criteria which state that if benefits exceed costs when both arc mcasured by a common yardstick, thcn the project or activity is acceptable. The common yardstick can be either market or economic prices depending on whether market or economic profitability is to be measured.

The excess of benefits over costs can be expressed in a number of ways, and this has led to alternative hut equivalcnt investment criteria. The net economic benefit (NEB) can be used to indicate profitability or efficiency (Chenery 1961). If NEB for rice pro- duction is greater than zero, a country or region will have com- parative advantage in it. Likewise, the domestic resource cost (DRC) of producing rice can he nsed a5 a summary measure of comparative advantage. The DRC is the economic value of domestic resources (primary non-traded ?actors of production) in domestic currency units necessary tor earning o r saving a unit of foreign exchange. If the DRC for rice is le% than the appropriate price of foreign exchange or the shadow exchange rate (SER), then comparative advantage exists in rice production (Bruno 1965).

A survey of the literature reveals that a considerable amount of work has already been undertaken on intervcntion in agriculture. While Scandizzo and Bruce (1980) provide a general description of the methodologies for measuring agricultural price intervention effects, Pearson, Akrasancc and Nelson (1976) highlight the meth- odological issues relating to determining comparative advantage in rice production. In both papers, the importance of using economic prices rather than market priccs in the estimation of indicators of comparative advantage is stressed. Pearson, Akrasanee and Nel- son indicate the flexibility of the DRC concept and its usefulness for the rice sector. For both national and international organisa- tions, intraregional DRCs for rice, the sensitivity of DRC to changes in yield and international prices, and implications for investment in research and development and irrigation are all

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pertinent for planning. Schydlowsky's (1984) emphasis on the distinction between short and medium-run DRC is particularly relevant. Investment undertaken in the past creates a short-run comparative advantage which inay significantly differ from me- dium or long-run comparative advantage when investments are required. Alternatively. it is important to consider the possibility that comparative advantaze based on past investment may differ markedly from that based exclusively on new capital.

There are a number of empirical studies which give detailed descriptions of the nature and extent of government intervention in agriculture. Further, attempts have been made to quantify nominal and effective protection coefficients. Issues rclating to private versus social profitability have also been raised. In the Indonesian context, Djamaluddin's (1978) study of interregional comparative advantage in rice production provided the starting point for Saefuddin's (19x3) attempt at quantifying the domestic cost of mechanisatior. in West Java.

MEASURING MARKET DISTORTIONS: SUMMARY MEASURES

Table 2 gives the rates of nominal and effective protection for wet season paddy production in selected regions of Indonesia for 1983. The nominal protective coefficient on output (NPCO) equals the ratio of the actual farmgate paddy price on the economic farmgate paddy price While in Java, Bali and West Nusatenggara the domestic paddy price is lower than the border price equivalent, implying a disincentive to rice production, the opposite is true for the other regions. For Indonesia as a whole, the domestic paddy price approximated the border price equivalent.

The nominal protective coefficient on inputs (NPCI) equals the ratio of the actual farmgate prices of tradable inputs to their economic farmgate prices. Clearly, tradable inputs have been heavily subsidised in Indonesia. Interestingly, Java and Bali which faced the largest ouput price disiiicentivc also had the highest NPCIs, implying the lowest input subsidies. Alternatively, the regions which enjoyed thc highest level of protection on rice production also received the largest subsidies on tradable inputs.

The effective protective coefficient (EPC) on value added is a composite index which captures the effects of intervention on output and intermediate input markets simultaneously. EPC equals the ratio of value added at actual market prices to value added in economic prices. Table 2 shows that while in Central Java the input subsidies compenqated for the output price disincentive (EPC = l), West Java, East Java. Bali and West Nusatenggara

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22.1

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26 0

9L 0

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61'1

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68 0

$6 0

W'I

66 0

6P'I

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8CI

21.1

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8p'O

8VO

620

090

SS 0

550

00'0

(0'0

20'0

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PO'I

Lis1 FB'O

LB'O

160

E60

E60

92 I

801

821

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output and input price incentives. For the other regions, interven- tion led to higher private returns on land.

It should he noted that for all items used in the estimation of nominal and effective protective coefficients in Table 2, the econ- omic price includes the c.i.f. price plus internal transportation and distribution costs in arriving at the values of items at their point of destination or to the area under study. Thus, following Unnevehr (1984), attention has to he paid to transportation and marketing costs in arriving at the economic prices. Hence the divergence of the coefficients in Table 2 from unity is attributed to the cffects of administered prices, taxes and subsidies to paddy producers in the various regions.

PRIVATE AND ECONOMIC PROFITABILITY

Having described the impact of government through the summary measures or indicators, we now discuss the impact of this inter- vention on private and economic profitability. Priv-atr profitability is defined as private benefits minus private costs w-here both benefits and costs are valued at actual market prices. In the present case; the benefits are measured in terms of the quantity of paddy or rice produced, while the private costs include imputed costs plus actual expenses in all stages of production. The costs include primary factors such as labour, capital, land and foreign exchange, as well as tradable and non-tradable intermediate in- puts.

Economic profitability is defined as benefits minus costs, with both being valued at economic prices. The methodology described in Little and Mirrlees (1968) w-as used to derive the economic prices. Here the economic prices are expressed in border price equivalents. The tradable goods are valued at their c.i.f. or f .0.b. prices plus an adjustment that reflects internal transport and other costs; this gives the value of the commodities at their point of destination. Non-tradable inputs are decomposed into tradable components and primary factors. Two adjustments are used to derive the economic prices of the primary factors. First, their opportunity cost? are determined. Second, they are expressed in border price equivalents by applying a standard conversion factor which compensates for foreign trade distortions in the economy. An additional distinction is made he twen paddy and rice. Rice production includes paddy production plus milling, transportation. handling, storage and marketing. In this paper, profitability of paddy is measured at the farmgate, while profitability of rice is measured at the port of entry.

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The details of :he methodology, assumptions and procedures used to derive private and economic profitability are described in the Appendix. However, a brief discussion of the economic prices of the primary factors of production is relevant here. Hughes (1985) reports that there is an active market for hired labour in Indonesia and that it is becoming increasingly important and competitive. Hence, it is reasonable to use the prevailing wage rate for hired agricultural labour as a proxy for the marginal product of agricultural labour. World Bank calculations estimate the marginal product of unskilled labour in Java at 0.5 times the market wage rate, though this relationship is mainly due to season- ality. The wage observed during the peak season is assumed to reflect the marginal product of labour for six months of the year. In the off-season the marginal product of lahour is assumed to fall to zero. Since this paper deals with wet season paddy and rice production, the World Bank procedure justifies equating the market wage rate with the marginal product of labour. However, a shadow wage rate equal to half the actual market wage rate is used in the sensitivity analysis.

Land can be valued in three alternative ways. First, one could assume that land planted to padi sawah during the wet season has no alternative use and therefore has zero opportunity cost. Sec- ond, one might equate the value of land with the returns to land planted to an alternative crop or put to some alternative use. Third, one might use the rent paid by the farmer as the value of land. The last definition has been applied here because the Direc- torate General of Food Crops farm budget survey used in this study contains this information.

Following Hughes' (1985) recommendation, an accounting rate of interest of 12% has been used for Indonesia. The standard conversion factor (SCF) used to express non-traded commodities and factors of production in border prices equivalents is derived through a procedure described in the Appendix. The SCF is used to derive the shadow exchange rate needed in the domestic re- source cost analysis. The SCF was estimated at 0.9581 in 1983. Given an official exchange rate Rp YY4 per US$ in 1983, the shadow exchange rate is Rp 1.037.5 per US$.

Table 3 gives the private and economic profitability and dom- estic resource cost of rice production in selected regions of In- donesia for the wet season in 1983. Private profitability is defined as value added less factor costs and indirect taxes, all valued at market prices. The relationship between government support prices for the paddy, input subsidies for fertilisers, pesticides, insecti- cides, and irrigation and private profitability of paddy production

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TABLE 3 Privaie and Economic Profiiabiiif) and Domestic Resource Cos1 of Rice Production in Selected Regions of Indonesia,

I983 Wet Season

IS 83

-5o.m 23.56

4.27.

63.25

-2215

11.81

39.41

46.63

-1.01

4 2 3 1

24.30

13.60

.5224

-21.37

- 7 . 9

21 05

-8.20

17.81

48.95

60.04

18.50

-27.84

15.26

31.11

66.38

-13.78

I I 20

54 52

-214

39 49

84.98

104.35

48.35

-18.42

4871

865

1.345

1.1m 987

192

1,050

857

661

585

819

1.121

815

0 83

1.30

1.06

0.95

0.16

1.01

0.83 OM

0.56

0.79

1x9 0.79

needs to be explored. A comparison of the effective protective coefficients (EPC) in Table 2 and the private profitability of paddy production (PP) shown in Table 3 reveals that there is little relationship hetween the two. While paddy production in Aceh and South Kalimantan is highly protected, with EPCs of 1.38 and 1.30 respectively compared to an average EPC of 1.12 for In- donesia, both regions show the largest private losses from paddy production. On the other hand: West Java and West Nusateng- gara, which also experience private losses. show EPCs of 0.99 and 0.90 respectively. East Java and Bali with EPCs of 0.95 and 0.89 have relatively high PPs. One conclusion that emerges from the comparison of the EPC and PP is that primary factor costs are likely to play a key role determining private profitability in paddy production,

Aceh, South Kalimantan and West Java have the highest factor costs. While for Aceh and South Kalimantan factor costs other than land rent are the highest, West Java has the highest land rent. In Aceh and South Kalimantan the situation is aggravated by their indirect tax rates which are the highest of all the regions. The coexistence of high negative PP and continued production of

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paddy in Aceh, West Java and South Kalimantan is puzzling. It may be due to problems of valuing costs which include both actual and imputed elements. The important imputed elements are fam- ily labour and rent; both involve problems of valuation. Handoko, Hart, Papanek and Partadiredja (1982). analysing data from 1971 and 1978 for Indonesia, found that the marginal product of labour is below the wage rate. They suggest three possible explanations. First, there may be non-economic reasons for hiring some work- ers. Second, the real cost of some hired labour may be lower than the wage rate because workcrs may be paid for one operation, but do other work without payment. Third, and perhaps most import- ant, the marginal labour is family labour which has a lower oppcrtunity cost. The second and third reasons cause serious valuation problems for labour. However. in the early 1980s rapid agricultural growth has led to tightening labour markets (Collier et al. 1982), and real wages have increased (Mazumdar and Sawit 1986). It is therefore likely that the valuation problem is less severe for labour in 19x3 than it would have been in the 1970s.

For the three regions with the highest PP, South Sumatra, East Java and Bali, the reasons for high profitability differ. The high level of protection indicated by an EPC of 1.49 for South Sumatra is an important factor. For East Java and Bali, on the other hand, it is the high level of private efficiency indicated by low factor costs which explains the high PP.

Table 3 also shows the economic profitability (EP) of paddy production. Three points should be kept in mind when comparing the economic and private profitability of paddy production. First, for paddy output the economic price of paddy is equal to the market price divided by the nominal protective coefficient on output (NPCO). If NPCO is greater than 1, the economic price will he lower than thc market price and vice versa. Thus, while for Java. Bali and West Nusatenggara which have NPCOs of less than 1, the economic price exceeds the market price for paddy, for the other regions the economic price is lower than the market price. Second, the economic price of tradable inputs is equal to its market price divided by the nominal protective coefficient on inputs (NPCT) Thus for all regions taken together. the economic price of inputs exceeds market price. Third, while the market wage rate and land rent are assumed to represent the marginal products of labour and land respectively, the economic price of each is obtained by adjusting the relevant market price by the standard conversion factor. The above discussion demonstratcs that PP can exceed, fall short of or equal EP. For Java, Bali, West Nusateng- gara and South Kalimantan, EP exceeds PP. For the first three of

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these, this is due to their NPCOs being less than one, and to the adjustment for factor rentals. South Kalimantan's adjustment on factor rentals more than compensates for its NPCO of 1.07. In the case of the other regions, EP is less than PP. Here, the economic prices, being lower than the market prices, do not compensate for the adjustment of factor rentals.

The estimates of the econoinic profitability of paddy indicate that Aceh, North Sumatra. West Sumatra, West Java and South Kalimantan are incurring losses. Except for West Java which has a higher yield than the average for Indonesia during the wet season, the other four regions have lower-than-avera_ee yields. The nega- tive profitability of West Java is partly explained by the high opportunity cost of land of Rp 224,512/ha against the average for Indonesia of Rp 129,162iha for the wet season.

A comparison of the eEective protective coefticients (EPC) in Table 2 and the economic profitahility (EP) of paddy production in Table 3 reveals that therc is a negative relationship betw-een EPC and EP. The Spearman rank correlation coefficient between EPC and Ep is -0.6273 and ir vgnificant at 5 % . Thus it appears that the more inefficient paddy production is in a givcn region, the greater is the protection offered.

Having compared the private and economic profitability of paddy production. we now move to the issue of the economic profitability of rice production. Before proceeding, we wish to again remind the reader that in addition to paddy production, rice production also includes milling transportation, handling, storage and marketing. It should also be noted that in computing the economic profitability of rice production, the conversion factor used for paddy (gnbali) to rice was 0.65. Thus the absolute magni- tudes of economic profitability of paddy and rice production will differ on two counts' rice production includes more activities than paddy production, and one kg of paddy converts to 0.65 k s of rice. For example. while the economic profitability of paddy production in Indonesia in the aggegate is Rp 13.60 per kilo (Tahlc 3). the economic profitability of rice production is Rp Y.11. The profit- ability of Rp 13.60 for paddy is equivalent to Rp 20.9 (13.60 t 0.65) for rice. Thu? the economic profitability of rice marketing activities can be inferred to he Kp 16-81 (37.71-20.9)

As already pointed out, the economic profitability of rice pro- duction and the domestic resource cost (DRC) of producing rice are alternative but equivalent ways of expressing the net economic benefits of rice production. If the economic profitability of rice production is greater than zero, this implies that the domestic resource cost of earning or saving one unit of foreign exchange

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from producing rice is less than the shadow exchange rate (SER). Table 3 shows that on the whole, Indonesia has comparative

advantage in wet season rice production since its DRC1SER ratio is 0.83. However, Aceh, South Kalimantan, North Sumatra and West Java do not have such comparative advantage. While the former three regions produce below-average yields. West Java produces higher-than-average yield?. As stated above, Aceh and South Kalimantan have relatively high other-than-land factor costs, while apprtunity cost of land is the highest in West Java. It should be noted that thc DRC/SER ratio of 1.01 for West Java implies that this region's comparative disadvantage is marginal. In the case of North Sumatra. a relatively low yield is combined with a relatively high tradable input element of $104/ha compared with an average of S911ha for Indonesia on the whole.

A comparison of EPCs for paddy production in Table 2 and DRCs for rice production in Table 3 indicates a positive relation- ship between the two. The Spearman rank correlation coefficient between these. two variables is 0.5818 and is significant at 6%. This implies that the more inefficient rice production is in a certain region, the greater is the protection offered.

An alternative way of looking at the question of comparative advantage is to determine the break-even c.i.f. price of rice (US$/ ton) at which DRC equals the shadow excllange rate. Table 4 provides this break-even price for the various regions. While Bali and East Java break even between $174 and $194 per ton, West Nusatenggara, South Sulawesi, South Sumatra and Central Java break even between $224 and $240 per ton: North Sumatra. West Java and West Sumatra break even between $268 and $293. The overall break-even price for wet season rice in Indonesia is $241 per ton. The prevailing c.i.f. price for rice imports to Indoncva in 1983 was $279 per ton.

SENSITIVITY ANALYSIS

DRC estimates are likely to be sensitive to the c.1.f. price of rice, labour costs and land rents. The sensitivity analysis highlights the c.i.f. price of rice as the dominant external factor and labour costs as the dominant internal factor.

Indonesia has traditionally been an importer of rice. Rice irn- ports rose from 0.5 million tons in 1968/69 to a peak of 2.6 million tons in 1979-80. Between 1980/81 and 1984185 rice imports steadily declined. In fact. in 1984/85 Indonesia became a net importer of rice and in 1985186 it exported 0.5 million tons. This fact. together with the increased supplies of rice in the world market have led to

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Figure 1

FOB Bangkok ($!Mr]

falling world rice prices. For example, the f.o.b. Bangkok price of white rice 5% hrokens per ton declined from $257 in January 1984 to $224 in Dcccmber 1984, and then to $210 in Oc!ober 1985. In the base year (1983) analy+ of DKC, the f.o.h. Bangkok price for white rice 5% hrokcns was $277 per ton. This was used as the starting point to determine the economic price of rice in DRC estimates. Figure I depicts. for Indonesia as a whole, the ratio of domestic resource cost to shadow exchange rate (DRCISER) at alternative international rice prices. These ratios are derived on the assumption that Indonesia is a net importer of rice. The SfR and cost structure for the 19x3 base year are used. The actual f.0.h. Bangkok price for white rice 5% hrokens is used for the period 1977 to 1985. The 1986 and 1987 prices are the projected rice prices made by the World Bank in January 1986. All prices are expressed in constant 1983 dollars. Clearly, Indonesia had a com- parative advantage in rice production at prices prevailing between 1977 and 1984. However: at the price prevailing in 1985 and for

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prices projected in 1986 and 1987, Indonesia, on average, does not possess comparative advantage.

Of course, Indonesia grows many varieties of rice and the spread in price between the highest and lowest grade is very considerable.’ That export rice has been of inferior quality can be determined from the fact that export contracts for Indonesia arranged in 1984 for re-export of rice imported in 1983 realised $220!ton hut 1985 exports of lower quality Indonesian rice realised only $150/ton. Indonesian rice for export is more comparable to white brokens A-1 super rice than to 5’!6 brokens rice used in the analysis in Figure 1 where rice was assumed to be imported. The f.0.b. Bangkok price of white brokens A-1 super per ton declined from $202 in January 1984 to $189 in December 1984, and then to $165 in Octoher 1985.

The sensitivity analysis uses the f.0.b. Bangkok price of white brokens A-I super of $165 per ton in October 1985. A comparison with the break-even c.i.f. price at which domestic resource cost equals the shadow exchange rate reveals that at this price no region in Indonesia has comparative advantage in rice production (Table 4). If, on the other hand. we assume that the quality of Indonesian rice improves to 5% brokens. then at the October 1985 price of $120 per ton only East Java and Ball have comparative advantage in rice for export. Clearly, the prospects for profitably exporting rice from Indonesia are bleak unless wrorld prices in- crease considerably.

So far we have assumed that the market wage rate is equal to the marginal product of labour. The shadow wage rate was derived by adjusting the market wage rate by the standard conversion factor. The sensitivity analysis assumes the shadow- wage rate to he half the market wage rate. This is the traditional World Bank assump- tion. Assuming that the c.i.f. price of rice is $279 per ton: Table 4 shows that all regions in Indonesia have comparative advantage in rice, Alternatively. the asumption of the shadow wage rate being equal to half the market wage rate was combincd with an f.0.b. rice price of $165 per ton. Under these assumptions only East Java and Bali have comparative advantage in rice exports.

The sensitivity analysis points to the need for careful analysis of the impact of Indonesia’s entry into the world rice market on international rice prices before making a definitive judgement concerning regional comparative advantage in rice production in

21Y8J data published hy the Central Bureau of Statistics show that v~holesale prices 01 rice tn Jakarta vary from Kp 19.820 per quintal for Cianjur Kepala to Rp 30,632 prr quintal f o r C-4 Super (Sioiisilk Harga Perdogangan Rcrar Beherapa Kornoditr dz Jokarra dan di Pasar Inrernusionol)

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TABLE 4 Sensrtrviry Anulysis"

865

1.345

1.103

987

792

1.050

857

651

585

819

1.127

815

241

345

293

268

224

282

240

194

174

230

298

230

658

961

833

762

622

841

674

5 m

416

635

769

647

1,310

1.952

1.772

1,490

1239

1.680

1,328

1.M8

791

1.253

1.626

1.125

a Shadow exchange m e (SER) = 1.037.5

C . d pn0c in ncz rn bare snlcvlslm = J279bn

Indonesia. Timmer (1986) estimates that 'an increase in Indone- sia's demand for imports of one million tons raise: the world price (of rice) by $50 per ton. The switch between 1980 and 1985 from importing two million tons to exporting half a million tons could account for a decline of $125 per ton in world rice prices.' Two further points are importcnt. First, the short-term prospects for world rice prices are not promising, as global rice stocks are expetted to further increase to 51 million tons in the season ending in 1985. Second, while the f.0.b. Bangkok price of 5% brokens ricc fell by 175: between October 1984 and 1985, during the same period the f.0.b. Bangkok price of white brokens A-1 super fell by 29%. It is the latter which is of greater relevance to lndonesia as a net rice exporter, given the low quality of the surplus stocks.

CONCLUSIONS

The objectives of this study were to analyse the impact of price intervention in the rice sector on private profitability, and to determine economic profitability and its implications. In addition, the Government's rice program which was implemented to cushion

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consumers from world price fluctuations, to increase farmer in- comes and to raise the level of self-sufficiency, needs to he re- assessed. It must be remembered that this paper examines wet season rice production in selected regions of Indonesia in 1983; thus the conclusions drawn have the limitations associated with one-point analysis.

The summary measure or indicator used to determine the im- pact of price intervention in the output and input markets is the effective protective coefficient (EPC) on value added. While the mean EPC is 2.18, the minimum and maximum EPC are 0 89 and 1.62 respectively. Thus the range of distortions emanating from policy intervention is substantial. In this context, Bertrand and Vanek's (1971) finding that piecemeal policy changes which reduce extreme distortions result in welfare improvement has relevance here. For example, a policy recommendation that can he made immediately is that the output price incentive for Aceh and Su- matra and the disincentive for Java, Bali and West Nusatenggara should be reduced. Likewise: the input subsidies for Aceh and Sumatra should he reduced. These policy changes would reduce the range ot the EPC for rice among the various regions and would lead to improved efficiency and welfare.

The above recommendation is closely related to the important finding that there is a significant negative relationship between the EPC and economic profitability in paddy and rice production. This means that the more inefficient the region is in producing paddy or rice, the greater is the level of protection offered and the distortion introduced. Further, as is well recognised: a reduction in the distortion introduced in an economy will lead to greater efficiency.

Despite the price intervention policies currently in place. private profitability of paddy production is negative in Aceh and South Kalimantan. These policies have also Contributed to negative private profitability in West Java and West Nusatenggara. *While high factor costs other than land rents have contributed to negative private profitability in Aceh and South Kalimantan, high land rents have led to negative private profitability in West Java. The high resource costs in Aceh, West Java and South Kalimantan result in negative economic profitability in paddy production. However, for North Sumatra and West Sumatra, removal of production incentives would lead to negative economic profitability.

While Indonesia has overall comparative advantage in rice production, Aceh, North Sumatra, West Java and South Kaliman- tan do not. Thus, at the margin, Aceh, North Sumatra and South Kalimantan should be discouraged from rice production. Rcduc- ing incentives in these regions would cause marginal lands to be

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transferred to other crops, leaving only the best lands to be sown to rice. West Java is a marginal case. Its DRCISER ratio of 1.01 is primarily due to the high opportunity cost of land. An important implication of this is that as industrialisation and other activities spread in West Java. rice production should be progressively reduced. Rice production should be encouraged in South Sumatra, Central Java, East Java, Bali, West Nusatenggara and South Sulawesi since these regions have strong comparative advantage in this activity.

Both Indonesia’s burgeoning rice stocks and its emergence as a net exporter, in contrast to its traditional role of being a major importer of rice, have had a major impact on the wrorld rice market. Not only are world prices likely to remain depressed, but an attempt on Indonecia’s part to export rice is likely to lower rice prices further (Timmer 1Y8h). While the f.0.b. Bangkok price of 5% brokens fell by 175: in 1985 the f.0.b. Bangkok price of white hrokens A-l super with which Indonesian export rice is compar- able fell by 29%: this IS highly significant. The analysis in this paper clearly indicates that while rice production as an import substitution activity is economically profitable in certain regions of Indonesia, rice production for export is not. Consequently, the possibility of diversification away from rice should be urgently explored.

The major objectives of the Government’s rice program have been fulfilled. Consumer interests have been protected, self- sufficiency achieved and farmer incomes have increased. How- ever, protection of farmer incomes in the future is likcly to be better served by crop diversification. The analysis of problems and prospects of crop divcrsification with an emphasis on economic profitability and comparative advantage is therefore a logical sequel to this study.

APPENDIX: DATA REQUIREMENTS, DEFINITIONS AND SOURCES

(a) Production Cost: Private und Economic. The description of the DRC methodology indicates that from the private cost data for rice production, we must derive the production cost in economic prices. In addition, the economic cost should distinguish between its foreign and domestic components. The Directorate General of Food Crops (DGFC) annually collects cost data for wet and dry seasons for the major food crops. A detailed account of both hired and family labour, intermediate inputs, and land rent and tax is given in the DGFC tables. Data for tractor and animal services

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and expenditure on irrigation were obtained from the Cost Struc- ture of Farms: Paddy and Palawija published by the Central Bureau of Statistics. All cost data for this study which pertains to wet season paddy for 1983 w’ere obtained trom the above two sources

The private and economic costs of seed are assumed to be identical, and seed is assumed to be a domestic component. This assumption reflects the fact that domestically-produced seed is used in Indonesia. Hence, following Bruno (1972): actual govern- ment policy rather than optimal government policy is used in making the DRC estimates.

The economic cost of fertiliser is likely to be sensitive to farm location. To the border price of fertiliser, distrihution costs which are location specific were added. Data for distribution cost by major region were obtained from the National Fertiliser Study I1 (1984). As pointed out earlier in the main text of this paper. for all items the border price equivalent includes the c.i.f. price plus internal transport and other costs in arrikiiig at the values of the items at their point of destination or to the area under study. Saefuddin’s (1983) study provided the composition vf distribution cost between transport and marketing, and between domestic and foreign components.

The implicit rates of subsidy for pesticide and insecticides are derived trom data provided in the Staff Appraiwl Rcport of the West Tarum Canal Improvement Project. World Bank, 1985. These subsidies are 85% and 61% respectively. The data provided in Saefuddiii (1983) are used for the foreign-domestic distinction. For irrigation service. the implicit rates of wbcidics for various regions are derived from Djamaluddin’s (1978) study; these form the domestic and foreign components. These subsidies vary from 93.3% in Java to 77.5% in South Sulawesi to 9.3% in Acch.

Hughes (1985) reports that there is an active market for hired labour in Indonesia: and that a large proportion of rural house- holds are dependent on earnings from wage labour. At the same time almost all farmers use hired labour during the crop season. Hughes states that ‘The labour market seems to be becoming increasingly important and competitive as traditional institutional arrangements and cultiv;ition practices are abandoned in response to changing economic incentives and technology. Thus, i t vvould seem reasonable to usc the typical wage rate for hired agricultural labour as the basis for our estimate of the agricultural marginal product.’ Consequently, we assume that the market wage rate represents the economic wage rate.

It is assumed that for dunglcompost, other intermediate inputs,

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and animal services. the market and economic prices are identical and that they are all domestic inputs. The land rent in the DGFC is the rent actually paid for a similar plot of land. The land market is assumed to be competitive and the market rent reflects the econ- omic rent. Hughes (1985) estimates that the accounting rate of interest for Indonesia i$ 12-13% per annum in dollar terms. Here we assume that the accounting rate of interert is 12%.

(b) Economic Cost of Milling and Marketing of Rice. The financial data from Mears' study (1981) were used to derive the cost structure for small rice mills i n 1983 piices. hlears' data were inflated by the wholesale price indexes to arrive at the cost data in 19x3 prices. The percentage change in the Wholesale Price Index (WPI) for non-electrical machinery is used to derive the adjust- ment factor for the rice mill and engine category. The percentage change in the general WPI and for non-residential construction are used to estimate the adjustment factors for the land and building categories respectively. Mears' data for investment cost is ex- pressed in 1975 prices. Thus the adjustment was from 1975 to 1983 prices. The percentage change in the WPI for maintenance ser- vices, general, refined oil for domestic consumption. manufactur- ing and nce are used to derive the adjustment factors for mainten- ance. salaries. fuel and oil, rubber roll. and rice bran respectively. Mean' data for variable costs are expressed in 1979 prices. It should be noted that the adjustment factor for fuel and oil includes an additional adjustmcnt which incorporates implicit subsidies. The additional adjustment is made by a conversion factor of 2.1, derived by comparing the wholesale price for diesel in Singapore and Jakarta in 19x3. Following the methodology specified in Saefuddin's study and using data from Mean' study adjusted for 1983 prices, the economic cost of rice milling was derived for the various regions.

In deriving the economic cost of marketing of rice, the objective was to go from the farmgate economic price of paddy to the economic price of rice at the port. so that the c.i.f. imported price of rice could be compared with the economic price of domesti- cally-produced rice. Data for port-to-distributor charges were derived from Mears' study. These cost data were inflated by the general wholesale price index in order to express them in 1983 prices. The derived 1983 cost figures for port-to-distributor charges were decomposed into economic domestic and foreign compo- nents by using Saefuddin's assumptions concerning transport and handling charges. Similarly, the transport costs to the territories were derived from Mears' study. However; the differentials in

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distribution costs for urea given in the National Fertiliser Study 11, 1984, were used as a proxy for the differentials in the transpor- tation cost across the territories in order to capture the differences in the cost of transporting rice across rcgions.

(c) Standard Converbion Factor and Shadow Exchange Rate. Since the standard conversion factor (SCF) approach has been used in this paper: it was also used to derive the shadow exchange rate needed to assess the comparative advantage of particular activities.

where X is the total value of exports, M is the total value of imports, TX are the net taxeq on exports and TM refers to the tariffs and taxes on imports. Alternatively,

OER SCF =- SER

where OER is the oflicial exchange rate and SER is the shadow exchange rate. Once SCF IS derived, then

OER SER =- SCF

This approach was used in determining the shadow exchange rate.

(d) Estimation of Domestic Resource Cost. The Directorate Gen- eral of Food Crops Data on farm budgets gives yield figures which are 40% to 50% higher than those provided by both the Central Bureau of Statistics (CBS) and by data published by ADB and FAO. Consequently, the CBS yield figures tor wet season paddy production were used. These arc more realistic and are compatible with aggregate data on production of paddy by region.

Indonesian rice imports peaked at 2.6 million tons in 1979180. The steady increase in domestic rice production led to a decline in imports, and in 1983184 Indonesia imported 1.1 million tons. Hence the c.i.f. price of rice is relevant for estimating the border price. Following World Bank practice. the following procedure was used to estimate the shadow price of rice in 1983:

US$/ton

Export Price, Thai 5% broken F.0.b. Bangkok 216.9 Quality Adjustment (90%) 249.2

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Freight and Insurance 30.01 C.i.f. Price Jakarta 279.2

Source: Commodity Price Data, World Bank Staff Appraisal Re- port Indonesia, West Tarum Canal Improvement Project, April 1985.

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