Is Contract Farming in the Indonesian Oil Palm Industry Pro-Poor?

By Cahyadi, Eko Ruddy; Waibel, Hermann | Journal of Southeast Asian Economies, April 2013 | Go to article overview

Is Contract Farming in the Indonesian Oil Palm Industry Pro-Poor?


Cahyadi, Eko Ruddy, Waibel, Hermann, Journal of Southeast Asian Economies


I. Introduction

Since the late eighties, the conversion of forest land to oil palm plantations has become an explicit policy of the Government of Indonesia (GoI) driven by better prospects in the world market for cooking oil, fats and, more recently, biofuels. This development has been augmented by private sector investments via mostly large agro industry corporations. In order to make this development pro-poor, the government has enforced the participation of smallholders in setting up new oil palm plantations. Corporations who want to invest in oil palm can obtain access to deforested public land only under the condition that it involves the surrounding local communities. Agro industry companies have largely complied with these requirements. Around 40 per cent of total national oil palm area is now either owned by smallholder farmers or under contractual arrangements with oil palm corporations (Ministry of Agriculture 2009). In the province of Jambi, which is the study area used for this research, 28 per cent of the oil palm area is owned by smallholders independently and 37.6 per cent is under contractual arrangements with corporations (BoA of Jambi 2009).

A number of reports and studies have pointed out the benefits of oil palm development for smallholders. The sector has absorbed at least 3.5 million labourers or 9 per cent of the total labour force in the agricultural sector (Ministry of Agriculture 2009). By comparing intensive plantation cropping in West Sumatra, Hardter, Chow, and Hock (1997) find that oil palm has increased the net income of smallholders to seven times that of their neighbours who are mainly involved in the subsistence production of food crops. In addition, Feintrenie, Chong, and Levang (2010) demonstrate that oil palm is able to generate higher returns to both land and labour compared to rubber or rice production.

Pafenfus (2001) identifies the lack of knowledge, high initial investment, and a long pay-off period as major barriers for smallholders to invest in oil palm production. One way to overcome these constraints is through the establishment of contractual arrangements between plantation companies and smallholders. Such contracts may include financial support for plantation development, quality control, price support, and supply obligation (Zen, Barlow, and Gondowarsito 2005; Vermeulen and Goad 2006).

On the other hand, there is some debate in the literature on the pros and cons of contractual arrangements that are commonly used as a component of poverty reduction strategies and sustainable development (Setboonsarng 2008; da Silva 2005; Eaton and Shepherd 2001; Baumann 2000). Some authors have found positive effects of contract farming in the oil palm industry such as more secure income (e.g., Sheil et al. 2009) and oil palm companies' social responsibility-related investments in health and education for local communities (e.g., Zen, Barlow, and Gondowarsito 2005). Other studies point to: unequal benefit sharing (Glover 1984; Glover and Kusterer 1990; Warning and Key 2002); lack of clarity over land tenure prior to plantation development and changing land values; unfavourable contractual schemes; and lack of contractual compliance by oil palm companies (Marti 2008; Colchester and Jiwan 2006; Rist, Feintrenie, and Levang 2010)--including the lack of transparency in determining oil palm price under the dominance of companies (Maryadi, Yusuf, and Mulyana 2007). Contract farming has also been criticized because it can cause increased concentration of land ownership, social differentiation among producers, and loss of independence for the growers (Echanove and Stefen 2005).

Studies of contract fanning have been carried out in other sectors such as rice, vegetables, or fruits (Kumar and Kumar 2008; Singh 2002; Miyata, Minot, and Hu 2009; Setboornsang, Leung, and Stefan 2008; Simmons, Winter, and Patrick 2005; Patrick 2004; Chang et al. 2006; Sharma 2008; Nagaraj et al. …

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