Local and national concerns: criteria and indicators

“Best bet” Land-use Systems

Country reports

Alternatives To Slash-And-Burn In Indonesia

Unique id: IDAZAZYB

Source file: D:\Projects\ASB\ASB Country and Thematic reports\Indonesia PhaseII report\Part IV-V .xml

Authors: Thomas P. Tomich, Meine van Noordwijk, Suseno Budidarsono, Andy Gillison, Trikurnianti Kusumanto, Daniel Murdiyarso, Fred Stolle, Ahmad M. Fagi, Iswandi Anas, A.F.S. Budiman, Kenneth Chomitz, Rebecca Elmhirst, Chip Fay, Hubert de Foresta, Dennis Garrity, Danan P. Hadi, Suryo Hardiwinoto, Kurniatun Hairiah, Genevieve Michon, Nu Nu San, Cheryl Palm, Soetjipto Partoharjono, Djuber Pasaribu, Eric Penot, Robert Simanungkalit, Martua Sirait, S.M. Sitompul, F.X. Susilo, David Thomas

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Alternative systems and technologies must be profitable and socially acceptable for smallholders; if not they have little prospect for adoption (hence impact). Part IV reports the empirical results of application in Indonesia of the methodological innovations of the ASB global working group on socioeconomic and policy issues (documented in Vosti et al. 1998). The GEF project did not provide funds for empirical research on these essential topics, which affect adoptability of land use alternatives by smallholders and also are the basis for assessing tradeoffs (if any) between national policy objectives and global environmental benefits. Thus, funding had to be sought from other sources – and was secured from the Asian Development Bank (ADB) and the Ford Foundation supplemented by additional funds from DANIDA, the Government of Japan, and others. The process of seeking additional funding delayed work on this key component of the research, which could not begin until funding, was secured in mid-1997.

Assessment Criteria. Empirical results for Indonesia for four sets of indicators – profitability, labor requirements, cash flow constraints, and household food security – will be presented in this part of the report. From among these, a sub-set of indicators will be selected for two of the sets of assessment criteria presented in Part I:

Criteria for smallholders’ socioeconomic concerns: production incentives, labor constraints, and household food security.

Criteria for policymakers’ objectives: growth and aspects of equity and stability

This part of the report will conclude with sections on tradeoffs and complementarities among smallholders’ concerns and policymakers’ objectives and on ‘scaling up’ the assessment from plots to landscapes and watersheds. Criteria for institutional barriers to adoption, which are concerns to both smallholders and policymakers, will be considered in Part V.

IV.1Profitability indicators

Since many of the land use alternatives in Sumatra involve perennials, the appropriate measure of profitability is the net present value (NPV, present discounted value) of revenues less costs oftradable inputs (fertilizer, fuel, etc) and of domestic factors of production (land, labor, management) over the full 25 year period considered in the analysis. Because it can account for input and factor costs as well as outputs and can handle time by discounting future values, this measure of total factor productivity is superior to partial measures of productivity (e.g., yield or output per unit labor).

The policy analysis matrix (PAM) technique provided the framework for estimating profitability indicators as well as the indicators of labor requirements and cash flow constraints discussed below. The ‘PAM’ is a matrix of information about agricultural and natural resource policies and factor market imperfections that is created by comparing multi-year land use system budgets calculated at private and social prices (Monke and Pearson 1989 is the basic reference). Private prices are the prices that households and firms actually face, so private profitability – the NPV at private prices -- is a measure of production incentives. Social profitability, calculated at economic (shadow) prices, removes the impact of policy distortions and market imperfections on incentives for adoption and investment. Thus social profitability —the NPV at social prices -- is an indicator of potential profitability(or comparative advantage). Divergences, the difference between private profitability and social profitability, are indicators of distortions, arising either from policy or from market imperfections and failures. The structure of the PAM is described in Table IV.1, which is taken from Monke and Pearson (1989, p. 19).

As pointed out by our colleague, Arild Angelsen, the list of potential corrections to arrive at social prices is quite long. The adjustments to derive social prices in these analyses focus mainly on policy distortions arising from trade restrictions. As discussed below, we also used a lower real discount rate (15% instead of 20%) to capture a rough approximation of the impact of capital market imperfections on the private cost of capital. We have used the same wage rate in both sets of calculations, implicitly assuming that there are no imperfections in the market for unskilled labor. While this is not completely true, it also seems that these imperfections do not have a significant effect in the unskilled labor market (see discussion of labor markets in Section V.4 below). The main omission here is that prices are not adjusted to reflect costs and benefits of environmental externalities arising from these production activities, such as smoke, ecological changes, and loss of watershed functions. These adjustments, which probably would be significant and which are necessary for the complete analysis, are not possible at this time because of lack of data. Filling this gap is a priority for future research, as discussed below in Section IV.5.

These studies focus on primary production in agriculture and forestry. To get the complete economic picture, especially regarding comparative advantage and growth potential, it would be necessary to extend these analyses ‘downstream’ to include the private and social profitability of processing activities, especially for timber, rubber, cassava, and palm oil. Each of these studies of processing activities (described in Appendix E) would be a major undertaking in its own right and was not feasible during Phase II work in Indonesia.

Table IV.1 Policy Analysis Matrix

		Costs
	Revenues	Tradable inputs	Domestic factors	Profits
Private prices Social prices Effects of divergences and efficient policy	A E I^3	B F J^4	C G K^5	D^1 H^2 L^6

¹ Private profits, D, equal A minus B minus C.

² Social profits, H, equal E minus F minus G.

³ Output transfers, I, equal A minus E.

⁴ Input transfers, J, equal B minus F.

⁵ Factor transfers, K, equal C minus G.

⁶ Net transfers, L, equal D minus H; they also equal I minus J minus K.

Ratio Indicators for Comparison of Unlike Outputs

Private cost ratio (PCR): C/ (A – B)

Domestic resource cost ratio (DRC): G/ (E – F)

Nominal protection coefficient (NPC)

On tradable outputs (NPCO): A/E

On tradable inputs (NPCI): B/F

Effective protection coefficient (EPC): (A – B)/ (E – F)

Profitability coefficient (PC): (A – B – C)/ (E – F – G) or D/H

Subsidy ratio to producers (SRP): L/E or (D – H)/E

Source: Taken from Monke and Pearson 1989, Table II.1, page 19.

To assure comparability across land use systems (and across ASB sites in Indonesia and Thailand), a regional short course on application of the PAM approach to natural resource management and policy analysis was be held in Chiang Mai, Thailand, 1-13 June 1997. Through participation in lectures and computer-based exercises, teams developed a common methodology for analysis of land use systems. The course, which was funded by ADB, involved eleven participants from Indonesia (see Annex D) plus eight from Thailand. The Indonesian teams trained in the course then undertook studies of six Sumatran land use systems selected for study in ASB Phase II. Five of these six studies were sub-contracted to Indonesian national partners listed in Table IV.2. The sixth, on transmigration systems, was completed by an ICRAF researcher (see Budidarsono 1998). Fortunately, except for the study of industrial timber, preliminary results of these ongoing socioeconomic assessments are available to be included in this report.

Table IV.2 ADB-Funded Grants for Socioeconomic Research in Indonesia

Research Topic	Researchers	Institution
Does shifting cultivation really cause deforestation? Economic analysis of shifting cultivation and five-year bush fallow in LampungProvince	Bustanul Arifin Agus Hudoyo	Department of Agricultural Economics and Rural Sociology, University of Lampung
Economic analysis of land use system for large scale plantations of oil palm and industrial timber estates	Retno Maryani Setiasih Irawanti	Forest Products and Forestry Socio-Economics Research and Development Centre, Ministry of Forestry
3. Economic analysis of large scale logging	Machfudh Wesman Endom	Forest Products and Forestry Socio-Economics Research and Development Centre, Ministry of Forestry
Analysis of the economic efficiency and comparative advantage of the Sumatran small-holder rubber using ‘PAM’ method	PrajogoU. Hadi Gelar Setya Budhi	Center for Agro Socio-Economic Research, Agency for Agricultural Research and Development, Department of Agriculture
Economic analysis of NTFP extraction in Rantau-pandan, Province of Jambi	Arif Aliadi Wibowo A. Djatmiko	The Indonesian Tropical Institute (LATIN)

Operational definitions for the six land use types were given at the end of Chapter I.

1. Community-based forest management,

2. Large-scale commercial logging

3. Smallholder rubber, including both rubber agroforests and rubber monoculture.

4. Large-scale plantations of oil palm and industrial timber estates

5. Upland rice with bush fallow

6. Transmigration systems, focusing on cassava and Imperata cylindrica (alang-alang)

See Tables I.2, I.3, and I.4 for additional specifications of these systems. Annex E contains the PAMs for the various scenarios and more information on each of the studies.

All of these studies use the macroeconomic parameters tabulated below because the data were collected in July 1997, when the exchange rate was about Rp 2400 / US dollar. By most assessments of economic fundamentals (e.g., purchasing power parity), the Indonesian Rupiah was not greatly overvalued at that time. The consensus was that the overvaluation of the Rupiah relative to the dollar may have been 10-15% in June 1997. Some expert analysts even expected the Rupiah to appreciate if it were floated in 1997 (Mc Leod 1997). To almost everyone’s surprise, the collapse of the Thai Baht in July 1997 spread to the Rupiah (among others). By January 1998, the Rupiah had fallen to over Rp 17,000 per US dollar. After a recovery below Rp 10,000, it had fallen again to over Rp 14,000 per dollar in June 1998. The reasons why Indonesia’s currency fell the furthest and has stayed down the longest rest with profound problems in its banks and other financial institutions compounded by the worst social instability and political uncertainty in 30 years.

The impact on land use incentives resulting from this monetary, social, and political crisis will be examined in Part VI. Although the causes of the regional financial crisis are not yet fully understood, they do not reflect fundamentals of the productive sectors of Indonesia’s economy. By any economic measure, the Indonesian Rupiah was extremely undervalued in mid-1998 as a result of the financial, social and political turmoil. (Under these conditions, people demand a huge premium to hold Indonesian currency.) To assess land use alternatives over the longer term, the macroeconomic parameters of July 1997 are a better guide than those that have prevailed during the crisis.

Macroeconomic parameters for PAMs	July 1997
Exchange rate	Rp 2400 / US$ 1
Wage rate in Sumatra	Rp 4000 / day
Real interest rates (net of inflation):
Private:	20 % per year
Social:	15 % per year

Real interest rates – that is interest rates net of inflation -- are the discount factors used to value future cash flows in current terms. As in most developing countries, capital markets in Indonesia are fraught with imperfections – some of which have been manifested in the financial crisis. Private interest rates (at least for smallholders, if not for large corporations that could secure subsidized credit) have been very high in real terms. In July 1997, formal sector lending rates were almost 30% pa and inflation was under 10% pa. Thus the private interest rate of 20% used in these analyses is a lower bound for the actual cost of capital for smallholders. The real social interest rate is less than the private rate and 10% is probably too low. So, somewhat arbitrarily, a rate of 15% has been used for the real social cost of capital, which is both the interest rate and the discount rate for calculating NPV at social prices. This difference between private and social interest rates is the main cause of divergences between calculations at private and social prices for many of the land use alternatives. The analyses are quite sensitive to the choice of discount rates, which unfortunately involves considerable uncertainty. Particularly for the private cost of capital, the subjective discount rate may be much higher (or lower) than the 20% real rate used here. Interest rates in the informal sector often exceed 100% per year. Stein Holden estimated that the average subjective discount rate (rate of time preference) among transmigrants in Riau exceeded 90% (Arild Angelsen pers comm).

On the other hand, as Angelsen has pointed out, ‘desire to claim or secure land rights may modify the effect of high discount rates.’

An activity with NPV less than zero is ‘unprofitable’ by definition. This does not necessarily mean that there are no positive cash flows. Instead, it means that it would be more profitable to do other things with the land, labor and capital than to devote them to this activity. If land is scarce, the NPV estimates measure returns to land because they are the ‘surplus’ remaining after accounting for costs of labor (including imputed value of family labor), capital (through discounting), and purchased inputs.[1] (To the extent that management is a scarce factor, it also would be included in the residual.) We also present a measure of returns to labor, the wage rate that sets the NPV equal to zero. This calculation converts the ‘surplus’ to a wage after accounting for purchased inputs and discounting for the cost of capital; no surplus is attributed to land. This measure of returns to labor is valid when land is abundant and labor is scarce. Returns that exceed the wage, Rp 4000 per day, mean the activity will be attractive to family members compared to off-farm work or would justify hiring labor.

Although local land abundance with household labor scarcity has prevailed historically and certainly continues in the ASB sites in Brazil and Cameroon, this fundamental relationship seems to be shifting in Sumatra. Nevertheless, it still is reasonable to believe that local land abundance and household labor scarcity continue in the forest margins, at least from the point of view of smallholder households in central Sumatra. This is supported by the result that returns to labor for rubber agroforests, the predominant smallholder land use, are almost identical to the wage rate (Table IV.3). This implies that no ‘rent’ accrues to land under the dominant system and is consistent with land abundance (since the ‘rent,’ its opportunity cost, is near zero).

For these reasons, and to facilitate cross-site comparisons, returns to labor valued at private prices was selected as the indicator of profitability for smallholders’ production incentives. Private prices are used in this indicator to reflect actual incentives smallholders faced under policies in effect in mid-1997.

At the same time, local and national policymakers increasingly are making public policy decisions under conditions of land scarcity and labor abundance. Land certainly is a constraint that should be considered by policymakers in choices regarding development of large-scale estates versus smallholders and there are other reasons to believe these development strategies are mutually exclusive (Tomich et al 1995).

Returns to land valued at social prices will be used as the indicator for potential profitability from policymakers’ perspective. Social prices are used to indicate potential value added from this alternative if policy distortions and market imperfections were removed. This impact on value added is directly linked to policymakers’ growth objectives.

Table IV.3 Profitability Matrix, July 1997
Land Use System	RETURNS TO LAND			RETURNS TO LABOR
				Wage to set NPV to Zero
	NPV Private Prices	NPV Social Prices	Divergences	Private Prices	Social Prices
	Rupiah 000 / ha	Rupiah 000 / ha	Rupiah 000 / ha	Rp / person-day	Rp / person-day
Community - based forest management	8.0 to 16	9.4 to 18	(1.5) to (2.5)	11,000 to 12,000	11,000
Commercial Logging	(804) to (131)	(32) to 2,102	(2,233) to (773)	(17,349) to 2,008	7,,917 to 31,400
Rubber agroforest (seedlings)	1.6	73	71	4,000	4,100
Rubber agroforest (clones)	(95) to 2,202	234 to 3,623	(330 to (1,420)	3,900 to 6,900	4,200 to 7,700
Rubber monoculture	(167)	(993)	(826)	3,683	2,600
Oil palm monoculture	275	1,480	(1,204)	5,797	9,981
Upland rice/bush fallow rotation	(220) to (76)	(180) to 53	(37) to (130)	2,700 to 3,300	3,000 to 4,500
Monoculture cassava/Imperata cylindrica	(71) to 360	(315) to 389	135 to 243	3,895 to 4,515	4,085 to 4,455

Estimates of returns to land and returns to labor, each evaluated at private and at social prices, are presented in Table IV.3. The upland rice / bush fallow rotation stands out as being unprofitable, either in terms of potential profitability (returns to land at social prices) or smallholder production incentives (returns to labor at private prices). For the upland rice / bush fallow system, the higher (less negative) returns are for the fallow of ten years or more, which is no longer feasible. The lower (or more negative) numbers in the range correspond to short fallow shifting cultivation. These results are consistent with the disappearance of shifting cultivation in most of Sumatra’s peneplains and piedmont. Sustainable forms of continuous foodcrop production may be technically feasible in Sumatra’s peneplains, but often are not financially attractive because they require too much labor and too many purchased inputs. For this report, we have focused on cassava, which may be among the most profitable of the continuous foodcrop alternatives for the peneplains. The most profitable cassava system studied was an extensive fallow system without any fertilizer applications. Profitability at private prices was estimated at over Rp 545,000 per ha (see Appendix E). However, this example is not included in Table IV.3 because, as noted in Part III, these systems mine nutrients, exhausting the soil and reducing the range of future land use options. Two cassava systems that use fertilizer are included in Table IV.3, one with fertilizer applications from the first year and one with fertilizer beginning in the seventh year after forest clearing. Application of fertilizer from the first year after clearing (30 kg N; 60 kg P; and 60 kg K per year) is not profitable privately (negative Rp 71,000 per ha) or socially (negative Rp 315,000 per ha). These treatments and the agronomic results are taken from experiments conducted at the Biological Maintenance of Soil Fertility (BMSF) research project at the ASB benchmark area in Lampung. However, an intermediate approach (also reported in Table IV.3) with fertilizer applications beginning in year seven (50 kg N; 50 kg P) does produce relatively attractive returns at both private prices (Rp 360,000 per ha) and social prices (Rp 224,000 per ha). However, the longer-run sustainability of this system requires further study. Note that, because of chemical fertilizer price subsidies that were still in effect in mid-1997, cassava is one of the few cases where estimated ‘divergences’ are positive, indicating that policy increases private profitability.

Returns to labor are highest for community-based forest management (extraction of NTFPs), but these high returns are dependent on some mechanism to exclude outsiders. Thus, this system plays an important role for existing communities that can regulate access to forest lands. If, on the other hand, communities could not regulate access to their forests, one would expect the returns to labor from extraction of forest products to decline toward the wage rate. However, even under ‘open access’ one would still expect returns to labor to exceed the wage rate by some margin equal to a risk premium. The risks involved include possibility of failure to find products to extract and also the risk (and associated costs) of detection by officials, since many of these activities are prohibited.

The relatively low returns to land – only slightly above rubber agroforests – suggest that NTFP extraction is not a feasible alternative for large numbers of people, because there is not enough land for everyone to practice this extensive livelihood strategy. These results must be interpreted with some care, however, for three reasons. First, these extractive activities are highly site-specific. It may be that the study site is not representative. Only additional studies can resolve this. Second, as often is the case, at least part of this community forest is on StateLand and it is not clear how this problem of tenure insecurity might bias these results. On one hand, long run profitability may be overstated because of unsustainable harvesting (viz., songbirds and rattan). On the other hand, if the community or individual members had secure property rights, this might induce them to invest and to manage resources to increase productivity over time. Finally, as already noted, it was not possible to put a value on timber extraction, but it is likely that this is significant. We hope to be able to conduct a study of the economics of smallholder timber extraction in the future.

The results for commercial logging appear paradoxical, but this is because of policies that produce the biggest divergences for any of these land uses. First, the sustainable logging regulations – if they really are followed – reduce profitability, mainly by slowing timber extraction. Second, high export taxes (effectively an export ban) for logs and sawn timber depressed the domestic prices of logs from 50-70% below comparable world prices. (Timber export taxes were to be reduced to 30% by the end of 1998.) However, timber companies could get around both of these problems. First, as mentioned above, many companies circumvent regulations on timber extraction. Second, these typically are vertically-integrated firms producing products like plywood for the export market. Therefore, the best indicator of profitability of these activities for logging companies is the figure of just over Rp 2 million per ha, valued at social prices that reflect world prices of forestry products. When comparable estimates are available for industrial timber plantations, it seems likely that these will be more profitable than logging.

By all accounts, illegal logging is common, which seems inconsistent with these results of negative returns to logging at private prices. However, the major cost item for logging concessions -- establishing and maintaining logging roads -- is not incurred by illegal loggers. If one can get access to timber without having to invest in infrastructure (and at the same time circumventing various fees), logging can be very profitable.

One could argue that the estimated NPV of logging activities of over Rp 2.1 million per ha (about US$ 875) in mid-1997 should be added to the social profitability for all the other activities and to private profitability, at least for large-scale estates that often can market timber felled as a by-product of land clearing. Recall that natural forest cover is the starting point underlying these calculations (and all the other estimates in this report). Thus all the forest-derived land uses (rubber, oil palm, cassava, and even upland rice) started out with felling of forest timber. And, as already noted, there is substantial (but as yet unquantified) timber felling in conjunction with NTFP extraction.