EFFICIENCY AND COMPETITIVENESS OF RICE PRODUCTION IN RIAU

EFFICIENCY AND COMPETITIVENESS OF RICE PRODUCTION IN RIAU Suardi Tarumun University of Riau June, 2004

Table of Contents Summary... 3 Background and Research Objectives... 4 Research Method... 5 Research Results... 6 Description of Research Locations... 6 Results and Interpretation... 7 Output Transfers... 7 Tradable Input Transfers... 8 Domestic Factor Transfers... 8 Net Transfers... 9 Efficiency and Competitiveness of Production Systems... 9 Policy Implications... 10 Summary and Conclusions...10 References... 11 Appendices... 12 Appendix 1. Map of Indonesia... 12 2

Summary Indonesia produces about 46 million tons of unmilled rice and imports around 2-3 million ton of milled rice each year. Policymakers would like to close this import gap. Many constraints limit increases in rice production. In some areas, rice production is less profitable than perennial commodities, such as palm oil. Moreover, technological change in rice production has been slow in Indonesia since 1990. One continuing policy proposal has been to reduce the import gap by raising the rice tariff. This would increase the domestic price of rice and create additional incentives for growers to add to the acreage under rice and to increase the level of input use. However, in addition to creating incentives for inefficient resource use, increasing the domestic price of rice would have an adverse welfare effect on non-rice producers who must purchase rice. Most of these consumers live below the poverty line. This study uses the PAM methodology to examine the efficiency and competitiveness of rice production in Riau. The field work shows that all three rice production systems in Riau were privately profitable (competitive) in 2003. The system in Rokan Hilir also was socially profitable (efficient), but the system in Indragiri was slightly socially unprofitable (inefficient). (Firm conclusions could not be drawn about the efficiency of the system in Rokan Hulu because it was not possible to estimate the social opportunity costs of land in that region.) The tariff on rice imports provided a positive output transfer in all three farming systems. If the government were to remove the tariff on rice, the taxes on tradable inputs, and the credit subsidies, the rice farmers in Rokan Hilir and Rokan Hulu would still generate profits, but the system in Indragiri Hilir would lose money. But at the assumed long-run world price for rice of $200 per ton and equilibrium exchange rate of Rp 9000/US$, all three systems would generate healthy private and social profits. In Indragiri Hilir, the weakest system, the long-run social profits would be 14% of social revenue, indicating an ability to compete well without policy transfers. 3

Background and Research Objectives Indonesia produces about 46 million tons of unmilled rice and imports around 2-3 million ton of milled rice each year. Policymakers would like to close this import gap. Many constraints limit increases in rice production. In some areas, rice production is less profitable than perennial commodities, such as palm oil. Moreover, technological change in rice production has been slow in Indonesia since 1990. Riau is one of the provinces in Indonesia that has programs to increase food and horticulture production 1. Some parts of Riau have the potential to produce rice in significant amounts because of the availability of good natural and human resources. The Government of Riau wants to increase rice production to improve farm incomes and to reduce the gap between production and consumption and, hence, the dependence on other regions for rice supplies. Every year Riau consumers need around 200,000 tons of rice to fill that gap. Based on ecological types, the paddy land in Riau can be divided into three categories lowland (paddy sawah), upland (paddy ladang) and tidal-affected land (paddy pasang surut). 2 The rice production systems can be characterized further by choice of technology. Lowland rice is usually cultivated more intensively with the use of fertilizer, whereas upland and tidal-affected rice systems are usually cultivated with minimal inputs. The total rice harvested area in Riau in 2002 was 129,000 ha, distributed in 11 kabupatens. Table 1 shows the lowland (paddy sawah) and upland (paddy ladang) harvested area of the major rice producing regencies in Riau. In that data set, the lowland category includes tidal-affected land as well. Most tidal land planted in rice is found in Indragiri Hilir, Rokan Hilir, and Bengkalis. Table 1. Harvested Area of Lowland and Upland Paddy in Selected Regencies in Riau, 2002 No Regencies / Kabupaten Lowland (Ha) Upland (Ha) 1 Kuantan Singingi 9,348 1,216 2 Indragiri Hilir 35,316 301 3 Kampar 6,129 2,369 4 Rokan Hulu 3,341 7,922 5 Bengkalis 13,350 2,210 6 Rokan Hilir 28,885 395 The objectives of this research are to evaluate the efficiency and competitiveness of rice production systems in Riau Province based on ecological characteristics and technology and to 1 The Riau Government has introduced a controversial organic-vegetable farming scheme in cooperation with the government of Singapore to fulfill the high demand for healthy and cheap vegetables from Singaporean consumers. 2 Lowland rice is grown in mud and requires a lot of water, while upland rice is grown without requiring much water. Both types are rainfed. 4

evaluate the impact of policy changes on rice profitability. Rice output can be increased through improvements in technology, expansion of agricultural infrastructure, or positive incentives to producers to increase their production. By showing the impact of policy changes on the profitability of rice production systems, the results of this research can provide valuable guidance for policymakers in Riau Province. Research Method Upland rice areas are small. Upland rice production requires much land for rotation, and planted area is getting squeezed due to competition with other land uses. The production of paddy ladang is not significant because of small planted area and low productivity. The average productivity (yield) of paddy sawah is 4 tons per ha while that of paddy ladang is only 2 tons per ha. Therefore, paddy ladang systems are not analyzed in this study. Only lowland and tidal-affected rice systems are evaluated. The representative lowland system is the good irrigation system that does not depend directly on rainfall. The tidal-affected land is divided into two types one with relatively good irrigation management (improved) and the other with simple irrigation management (traditional). Data for each rice production system were collected in the three different kabupatens (regencies) shown in Table 2. Table 2. Location of the Three Representative Rice Production Systems No Location Kabupaten Kecamatan 1 Rokan Hilir Rimbo Melintang Production System Tidal affected lowland (traditional) 3 Rokan Hulu Rambah Samo Irrigated lowland 4 Indragiri Hilir Pulau Kijang Tidal-affected lowland (improved) The Policy Analysis Matrix (PAM) method is used to measure the degree of efficiency and impacts of policy for the three rice production systems. To apply the PAM method, the first step is to construct a table of private budgets, using quantities and prices of inputs and outputs in actual market prices. The next step is to construct a table of social budgets, using social prices for both inputs and outputs. The social prices of tradable commodities are given by comparable world prices. These prices are compared with domestic prices at the identical location, over the same period, and with comparable quality. Social prices for tradables are found by calculating import parity for goods that substitute for imports and export parity prices for goods that enter export markets (Pearson and Gotsch, 2003). Table 3. Policy Analysis Matrix Revenue Costs Tradable Inputs Domestic Factors Profits Private A B C D Social E F G H Divergences I J K L 5

The PAM method is illustrated in Table 3. The top row is based on budget data collected from farmers, traders, and processors. The second row is based on the social opportunity costs of commodity produced and inputs used. The third row indicates the differences between the top row (private) and the second row (social), which are called divergences. These divergences indicate how much the private budget differs from social budget. The differences are caused by either market failures or policy distortions. This research was undertaken for ten months from September 2003 through June 2004. The field survey was conducted in September 2003. The primary data were used to verify secondary data that were collected beforehand by others. This research used secondary data that had been collected by government officials and students of the Agricultural Economics Department, Riau University. Description of Research Locations Research Results Three locations were chosen to represent the three rice framing systems, based on ecological characteristics and technology (Table 2, above). Kabupaten Rokan Hulu was selected to represent the lowland paddy system with a relatively good irrigation system. The majority of farmers living in that area are Javanese who migrated from Java to Riau under the transmigration program. Generally, they are hard-working farmers who maintain their land properly. The government built the irrigation infrastructure. Although this kabupaten produces only about 10,800 tons of paddy (3 percent of the Riau s total production), it is an adequate representative of the relatively good irrigation system in Riau. The locations of all studied production areas are shown in the map in the appendix. Kabupaten Rokan Hilir is located in the northernmost part of Riau. Most of the land in this region is lowland with altitudes ranging from 0 to a few meters above sea level. The tides from the rivers affect the ecological landscape of the rice fields. Farmers do not need to irrigate the land because the water is supplied regularly by the river tides. During the rainy season, some of the rice fields are always wet (which is not optimal for rice growing) because the drainage system is not good. The rice farmers are local people and migrants from North Sumatra Province. The migrants purchase or rent land from the local people. Roads are poor and transportation costs are high. Kabupaten Indragiri Hilir is located in the southeastern part of Riau. The physiography of this kabupaten is similar to that of Kabupaten Rokan Hilir lowlands with significant river tides. The majority of the farmers in Indragiri Hilir are ethnic Bugis who migrated a long time ago from Makassar, South Sulawesi. The irrigation systems in this region are better than those of Rokan Hilir, and the drainage system is properly maintained. Kabupaten Indragiri Hilir is the largest rice producer in Riau. Some of the rice from this regency is sold to Jambi. 6

Results and Interpretation One objective of this study is to evaluate the efficiency of the three rice systems. Efficiency is measured by social profits the net change in national income that results from the introduction of the commodity system into the economy (Monke and Pearson, 1989). Social prices of tradable outputs and inputs are the comparable world prices that would result in the best allocation of resources and thus the highest generation of income. Table 4. Policy Analysis Matrices for Three Rice-Farming Systems Tradable Domestic Factors Total Revenue Inputs Labor Capital Others Costs Profits Rokan Hulu (Low-land rice farm, good irrigation system) Private 4,902,000 956,706 2,559,409 343,392 296,806 4,156,312 745,688 Social 4,316,496 880,569 2,559,409 399,410 296,806 4,136,194 180,302 Divergences 585,504 76,136 0-56,018 0 20,118 565,386 Rokan Hilir (Swampy-low land rice farm) Private 4,940,000 617,233 2,860,000 312,557 133,333 3,923,123 1,016,877 Social 4,528,004 594,358 2,860,000 375,068 133,333 3,962,760 565,244 Divergences 411,996 22,875 0-62,511 0-39,636 451,632 Indragiri Hilir (Tidal-land rice farm, relatively good irrigation) Private 4,763,070 974,688 2,938,650 363,739 72,222 4,349,299 413,771 Social 4,302,505 936,773 2,938,650 431,767 72,222 4,379,413-76,907 Divergences 460,565 37,914 0-68,028 0-30,114 490,678 Output Transfers The output transfer can be expressed as a ratio of private to social revenue, A/B, called the Nominal Protection Coefficient on Output (NPCO). Output transfers occur because domestic prices are higher than comparable international prices. These transfers vary across the regencies. The highest transfer is in Rokan Hulu (14%), followed by Indragiri Hilir (11 %) and Rokan Hilir (9 %). These output transfers arise because the Indonesian Government imposes protection on domestic rice through an import tariff of Rp 430/kg. However, the farmers in these three regions of Riau do not receive protection to the full extent of the import tariff. The protection is not fully enforced in these regions because it is very difficult to control rice smuggling across the borders between the many small ports of the Riau Archipelago and neighboring countries. The degree of protection among the three regencies also varies according to location and transport costs. Indragiri Hilir and Rokan Hilir are located on the coast. These two open regencies get less protection than inland regencies, such as Rokan Hulu. The private prices of 7

rice in Indragiri Hilir and Rokan Hilir are pushed down by imported rice from Port Klang Malaysia Tradable Input Transfers Tradable input transfers are defined as the difference between the total costs of tradable inputs valued in private and social prices. This transfer can also be stated as the ratio of private costs to social costs of tradable inputs (B/F) and is called the Nominal Protection Coefficient on Tradable Inputs (NPCI). The costs of tradable inputs that farmers paid were higher than comparable social costs. Farmers were taxed 9 % in Rokan Hulu and 4 % in both Rokan Hilir and Indragiri Hilir. The NPCIs arose from taxes imposed on fertilizers (TSP and KCl) and pesticides. The taxes were higher in Rokan Hulu because farmers used more taxable fertilizers and pesticides. Domestic Factor Transfers Domestic factor transfers arise from differences between the private and social valuations of labor and working capital. There were no differences between private and social costs for labor, because the labor market functioned well in all three studied areas. There were identical divergences between the private and social costs of working capital in the three systems. To help small-scale farmers access capital, the government established a credit scheme with subsidized interest rates of 20 % per annum. That scheme operated in all regions of Riau. The subsidized interest rate was lower than the social interest rate for working capital, which was assumed to be 24 % per annum. Rice farmers thus paid only 83 % of the full costs of working capital, and the government paid the rest. Rice farmland in the three areas has different ecological characteristics. Rice farmland in Rokan Hulu has relatively good irrigation. The alternative uses of that land are oil palm and rubber tree plantations. Although the government strongly encouraged the farmers to plant paddy, some farmers planted oil palm or rubber trees, especially if the land was far from irrigation water. There was insufficient time to calculate the social profits of either oil palm or rubber. Hence, land costs had to be omitted and profits are defined as the return to land and management. In light of this information constraint, the social profits for Rokan Hulu, reported in this study, include the social opportunity costs of land and thus the estimates of efficiency and comparative advantage are incomplete. The tidal-lowlands in Rokan Hilir and Indragiri Hilir are wet most of the time so that do not have any alternative use other than paddy sawah. The rice farms are the best and only commercial use of the tidal lowlands. The social opportunity costs of these lands thus are zero, and the social profits reported for these two systems are good measures of efficiency and comparative advantage. 8

Net Transfers The net transfer, indicated by L = (I - J K) in the PAM table, is the sum of positive and negative transfer effects on revenues and costs. All three systems in this study have positive net transfers, benefiting farmers, caused mainly by the positive NPCOs. The Subsidy Ratio to Producers (SRP) is the output tariff equivalent if the net effect of all policy transfers were carried out solely through tariff on output. SRP is calculated by comparing the net transfer to the value of output in world prices, L/E. The SRP for Rokan Hulu was 0.13, indicating that the net transfer could be created solely by imposing 13 % tariff on rice if all other divergences were eliminated. The comparable results were 10 % for Rokan Hilir and 11 % for Indragiri Hilir. Efficiency and Competitiveness of Production Systems Are the rice production systems in Riau efficient? This question can be answered by observing social profits or by calculating the Domestic Resource Cost Ratio (DRC), the ratio of domestic factors, valued in social cost, to social value added. A DRC less than one shows efficiency (social costs less than social revenues), whereas a DRC less than one shows inefficiency (social costs greater than social revenues). Rice production in Rokan Hulu and Rokan Hilir is efficient since social profits are positive. But the system in Indragiri Hilir is inefficient since social profits are negative (Table 3). The DRCs for Rokan Hulu, Rokan Hilir and Indragiri Hilir are 0.95, 0.86, and 1.02, respectively. The results for the calculations of competitiveness of the three production systems are shown in Table 5. All the three system are competitive because they are profitable in private prices. However, the profits mainly come from the protection on output, which contributes 78 % in Rokan Hulu and 111 % in Indragiri Hilir. Other influences on profits are taxes on tradable inputs and credit imperfections. The total divergences amount to about 61 % in Rokan Hulu, consisting of a positive transfer of 78 % from the higher output price, a 10 % negative transfer from the taxes on tradable inputs, and a negative transfer of 7 % from credit market imperfections. Table 5. Competitiveness of the Three Rice Production Systems Rokan Hulu Rokan Hilir Indragiri Hilir Private Profits (Rp) 745,688 1,016,877 413,771 Private Profits (%) 100 100 100 Protection on output (%) 78.52 40.52 111.31 Tradable input (%) -10.21-2.25-9.16 Credit imperfection (%) -7.51-6.15-16.44 Total Divergence 60.80 32.12 85.71 9

Policy Implications If the government were to remove all of the distorting policies the tariff on rice, the subsidy on capital credit, and the taxes on tradable inputs could Riau farmers compete with imported rice? If the three policies were all eliminated, the rice production system in Rokan Hilir would earn profits of 12.5% of revenue and that in Rokan Hulu would earn profits of 4.2% of revenue. However, the system in Indragiri Hilir would make losses of 1.8% of revenue. Table 6. Efficiency of the Rice Production Systems in Riau Social. Profits % of Social. Revenue Social Profits 1) % of Social. Revenue 1) Rokan Hulu 180,302 4.18 782,906 16.9 Rokan Hilir 565,244 12.48 1,218,065 23.51 Indragiri Hilir -76,907-1.79 706,577 13.89 Notes: World rice price = $200 per ton; Exchange rate = Rp 9000/US$; A recent study (Pearson, 2003) contains an estimate of the long-run world rice price of $200 per ton (by an economist at the International Rice Research Institute) and an estimate of the equilibrium exchange rate for Indonesia of Rp 9000 per US dollar (by an economist at BAPPENAS). Under these long-run assumptions, the three systems of rice production in Riau would all be highly profitable (Table 6). Summary and Conclusions All three rice production systems in Riau were privately profitable (competitive) in 2003. The system in Rokan Hilir also was socially profitable (efficient), but the system in Indragiri was slightly socially unprofitable (inefficient). Firm conclusions could not be drawn about the efficiency of the system in Rokan Hulu because it was not possible to estimate the social opportunity costs of land in that region.. The tariff on rice imports provided positive output transfers in all three systems. The NPCOs ranged from 9% to 14%. The NPCIs were also positive and ranged between 4% and 9%, reflecting taxes on tradable inputs. But farmers received subsidized credit and paid only 8 % of full working capital costs. If the government were to remove the tariff on rice, the taxes on tradable inputs, and the credit subsidies, the rice farmers in Rokan Hilir and Rokan Hulu would still generate profits, but the system in Indragiri Hilir would lose money. But at the assumed long-run world price for rice of $200 per ton and equilibrium exchange rate of Rp 9000/US$, all three systems would generate healthy private and social profits. In Indragiri Hilir, the weakest system, the long-run social profits would be 14% of social revenue, indicating an ability to compete well without policy transfers. 10

References Monke, Eric A. and Pearson, Scott. R (1989). The Policy Analysis Matrix for Agricultural Development, Ithaca: Cornell University Press. Pearson, Scott A. and Gotsch, Carl (2003). Application of Policy Analysis Matrix in Indonesian Agriculture. Pearson, Scott A., Bahri, Syaiful and Gotsch, Carl (2003). Is Rice in Indonesia Still Profitable? The Bappenas/USAID/DAI Food Policy Support, Activity and the Center for Agro-Socio Economic Research. 11

Appendices Appendix 1. Map of Indonesia 12