Contract Farming and Risks for Smallholders in the Oil-Palm Industry in Indonesia

Eko Ruddy Cahyadi, “Contract Farming and Risks for Smallholders in the Oil-Palm Industry in Indonesia” (PhD thesis, Leibniz University of Hannover, Germany, 2013).


Abstract

INDONESIA'S CONTRACT-farming policy has led to the rapid expansion of oil-palm smallholdings. Oil palm offers attractive returns for smallholders, but contract farming can suffer from asymmetric information and can therefore be inefficient and unfair. This questions the effectiveness of such schemes in reducing poverty. Furthermore, the nature of the oil-palm industry exposes smallholders to certain risks, such as price volatility and crop disease. While some studies suggest that contract farming can be an effective way for smallholders to manage risk, the role of shocks in pushing oil-palm smallholders into poverty demands further investigation.

This thesis aims to improve the understanding of the effects of contract farming in Indonesia’s oil-palm industry on smallholders’ wellbeing. It has three specific research objectives: (a) to assess whether and to what extent the poor benefit from contract farming; (b) to assess the degree of vulnerability to poverty among oil-palm smallholders, and to determine whether contract farming is an effective measure of reducing vulnerability to poverty; and (c) to investigate the relationship between subjective risk expectation, risk attitude and decision-making behaviour among oil-palm smallholders. It uses as its empirical base a household survey of 300 oil-palm smallholders in the province of Jambi, Sumatra.

Descriptive analysis shows that contract smallholders have substantially more land and income than non-contract smallholders. Moreover, they apply higher inputs and therefore generate greater yields. After controlling for a hidden bias, I confirm that contract participation has a positive effect on income. My investigation of the equity effect, however, shows that poor smallholders are unlikely to benefit from such participation.

This thesis also finds that contract smallholders experience oil-palm shocks more extensively than non-contract smallholders, because the former are more dependent on oil palm. On average, oil palm contributes more than 60% of the household income of contract smallholders and only 30% of that of non-contract smallholders. My analysis shows that contract participation can reduce price shocks but not production shocks. After assessing the vulnerability of smallholders, I identify four poverty typologies: structurally chronic, structurally transient, stochastically transient and non-poor. About 40% of oil-palm smallholders are classified as stochastically transient – that is, as the poor who at present are non-poor but could fall into poverty should they experience shocks. These results signal to policymakers that it is not enough to consider the effects of oil-palm development on income growth, and that there is a need to take future risks into account in order to develop proactive poverty-reduction policies.

While a simple means comparison shows that contract smallholders are significantly less vulnerable than non-contract smallholders, propensity-score matching (after having controlled for selection bias) shows that contract participation does not significantly reduce their vulnerability to poverty – in large part because contract farming is dominated by households with greater asset endowments. The results of my risk-behaviour analysis show that subjective expectation towards all risks is driven by the level of exposure to past shocks. Asset endowments are another important determinant. This thesis reveals that a plan for oil-palm investment tends to be encouraged by a high risk expectation in non-oil-palm enterprises and by a low level of risk aversion, and that it seems to be independent of risk expectations in the oil-palm industry itself.

Overall, this thesis suggests that Indonesia’s contract-farming schemes need to be more pro-poor, and that policymakers must take risk into account in their attempts to reduce poverty.[]

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Source: Bulletin of Indonesian Economic Studies, 49, 3 (2013): 381-382.