2. Recent Policy Influences on Rice Production

Scott Pearson, Rosamund Naylor, and Walter Falcon

This chapter reviews the complex set of relationships among rice strategies, policy instruments, economic variables, and food policy objectives as they have evolved since the early 1970s. The intent is to provide readers unfamiliar with the recent history of Indonesian rice policy with a summary of rice policy and production performance and to offer already knowledgeable readers an interpretive approach to understanding how strategies, policies, variables, and objectives have fit together. The modest goal, then, is to review the set of policy instruments available to Indonesian decision makers, whereas the more ambitious intention is to interpret these instruments' recent se in the context of food policy objectives.)

Recent Rice Policy in the Context of Food Policy Objectives 1

The chain of reasoning summarized here offers readers a set of guideposts as they work their way through the details of policy that follow. In response to the highly unstable world price of rice and detrimental short-run influences on the world price of Indonesia's decisions to buy or sell rice on the world market (described in Chapter 3), Indonesian policymakers in all of the New Order governments have given central place to the food security objective within their rice strategy of self-sufficiency. The desire for food security became even stronger during _1973-75, when world prices of rice reached historically unprecedented heights. To ensure that most consumers would have access to rice supplies at affordable prices, the government has carried out policies to influence two related variables in the rice economy-the stability of domestic rice prices and the level of Indonesian rice production. Food security thus was served by enacting price stabilization policies, involving public storage of rice and imports, and by creating incentives for expanded domestic rice production through the use of price level policy (guaranteed minimum rice prices to farmers and subsidies on fertilizers) and public investment policy (irrigation infrastructure and maintenance, transportation facilities, and research, development, and dissemination of seeds and technologies for high-yielding varieties [HYVs]).

Beginning in _1973-74, when oil prices surged upward, Indonesia enjoyed rapid economic growth and burgeoning government revenues, which permitted policymakers to give increasing attention to the equity objective of food policy, in particular to the desirability of increasing incomes of the rural poor. They saw that the uneven distribution of the oil boom income growth, which favored urban residents, could be offset at least in part by carrying out agricultural policies that encouraged generation of income and employment in rural areas. Price and investment policies that were intended principally to enhance food security by increasing domestic supplies of food also had the desirable side effect of redressing the imbalance of skewed income distribution between rural and urban areas. No trade-offs were necessary because both the objectives of food security and of rural-urban income distribution were furthered by policies that led to increased rice output.

In the early _198os, the world oil price began to slide downward and by the middle of the decade had settled in a range less than half of its ₁₉₈₀ peak. With the end of the oil boom, the Indonesian economy slipped into slow growth and entered a difficult period of macroeconomic adjustment. Accordingly, policymakers redoubled their efforts to find activities in the economy to enable income growth to occur efficiently, with less reliance on government budgetary expenditures. Agriculture, and especially rice production, became recognized as a prime source of efficient growth. Hence a third basic objective of food policy, efficient income growth, came to the fore of Indonesian rice policy. Once again, to the extent that rice (substituting for imports) could be produced efficiently, complementarity occurred among the objectives of food security, rural-urban equity, and efficient income growth; all could be advanced by policies that spurred growth of rice production.

The achievement of rice self-sufficiency (zero imports) in ₁₉₈₅ ended, at least temporarily, this happy complementarity among the three fundamental food policy objectives. Whereas income distribution favoring rural over urban areas would continue to be furthered by policies that promoted increasing rice production, any excess of domestic production over consumption would have to be exported or stored. Public storage beyond levels needed for food reserve stocks did little to improve food security. Instead, surplus stocks represented burdensome costs for an already strapped budget. Exports were costly as well because they required public subsidies to enter the world market. Whereas rice was competitive against the c.i.f. price of imports (with occasional implicit subsidies from consumers), domestic prices were well above f.o.b. prices for exports. Ironically, the attainment of self-sufficiency highlighted the inevitably close links between Indonesian rice policy and the world rice market. Rice supplies in excess of consumption needs did not create efficient growth of income, were not an appropriate vehicle for food security because they were too expensive to store in large quantities, but were still desired for improved income distribution in rural areas. Indonesian policymakers in the mid-ig8os thus faced a classic food policy trade-off in assessing the strategic alternatives for rice production.

Since 1985, the rice economy has been at or near self-sufficiency. As shown in Chapter 3, the world rice price went up about so percent in 1987, slipped back in 1988, and rose and fell again in 1989. Indonesian rice prices were raised in late 1987 and 1988 to stay in line with world prices and were about aligned with world prices in late 1989. Excess Indonesian public stocks were either exported with subsidy (in 1985-86) or injected into the domestic market to replace unexpected production shortfalls (in ₁₉8₇-88). Food reserve stocks were depleted in order to balance domestic supply and demand at higher prices during times of production shortfalls (1987-88) and then rebuilt when production recovered (1989).

Within only four years, Indonesia fluctuated from a situation of too much rice to one of too little to one of comfortable adequacy. As a result, new trade-offs have emerged among the basic objectives of food policy. Should Indonesia transfer scarce budgetary and consumer resources into rice production to avoid imports to the greatest possible extent (absolute self-sufficiency), invest enough so that production and consumption normally are in balance, using imports or exports to offset occasional gaps (trend self-sufficiency), or diversify out of rice and import as required (regular imports)?

Recent History of Policy Influences on Rice Production

Rice self-sufficiency and stable rice prices have been the focus of agricultural policy in Indonesia throughout the past two decades. The strategy adopted by the government in the late 1g6os to further these ends had two main policy components. The first was a comprehensive set of price policies that controlled the level and stability of consumer and producer prices of rice as well as the prices of important inputs such as fertilizer and pesticides. The second was public investment in modern rice-producing technologies and in the infrastructure and institutions needed to support the new technologies. The instruments used within each of these policy categories are discussed in the remainder of this chapter. To provide historical context on the evolution and impact of policy, information on rice output, income, and employment is summarized at the outset of this section.

Recent Performance of the Indonesian Rice Economy

Between 1955 and 1965, Indonesia had the lowest rate of growth in rice yields (o.2 percent per year) and rice production (1.2 percent) of any major rice producer. Between 1965 and 1985, it had the highest rates of growth (4.1 percent and 5.6 percent, respectively), with a dramatic spurt of 7.2 percent annual growth of output between 1977 and 1984. As shown in Table 2.1, rice production in Indonesia grew by nearly two and one-half times between 1968 and 1989, from less than 12 to over 29 million metric tons. Most of this expansion occurred during the second of these two decades, when average paddy (gabah) yields increased from 2.8 to 4.2

tons per hectare. Area planted to rice expanded by only about 1 million hectares during each decade, and so most of the output gain was attributed to intensive productivity increases rather than to extensive expansion of rice land. These production data provide evidence of the broad success of Indonesian rice policy in encouraging growth of rice output.

During this same twenty-year period, the structure of the entire Indonesian economy changed markedly. Table 2.2 illustrates the shift in the agricultural sector's share of national income. Although output of rice, corn, and soybeans more than doubled, the share of agriculture in national income fell from over one-half in 1968 to one-fourth in 1987. Within the agricultural sector, the contribution of rice to total GDP decreased from almost 20 percent to about 8 percent. The shares of both agriculture and rice in national income stopped their declines after 198o and increased somewhat through 1987. The declining share of agriculture in national income, even as agriculture itself grew rapidly, illustrates how quickly incomes were growing in the nonagricultural sector.

The share of total employment in the agricultural sector, including rice, also declined between the early 1970s and the mid-198os, although the number of people employed in the agricultural sector increased. Data in Table 2.3 indicate that virtually all of this decline in the labor share of agriculture took place in the 1970s, when the nonagricultural economy boomed. During the 1g8os, the agricultural sector maintained its share of employment at 55 percent because nonagricultural growth fell, off with the decline in oil prices and increased agricultural activity took up some of the slack.

Rice Price Level Policy

The immediate concern of the New Order government in the late 1g6os was to control consumer prices for rice because the short-term legitimacy of the government was highly dependent on the constituency of urban consumers. Stable and low rice prices were a critical part of the government's economy-wide stabilization program in the first five-year develop

ment plan (REPELITA I, ₁969_-73). A ceiling price for rice in urban areas was announced and enforced on Java as well as on the outer islands. During much of the 197os, producer and consumer prices were held below world market prices. From 1969 to 1976, a period encompassing first very low and then extraordinarily high world rice prices, the domestic price averaged 30 percent below the border (c.i.f.) price.

The cost of protecting consumers from fluctuations in the world market by subsidizing imports rose considerably with the unprecedented increases in the world rice price during ₁973 and ₁974. Although government revenues from oil exports grew concurrently because of the quadrupling of the world price of petroleum, for a brief time Indonesia was unable to purchase rice imports at any price. The country's vulnerability to the highly unstable world market conditions at the time gave strong support to the belief that complete self-sufficiency was a desirable strategy to guarantee food security.

During the mid-1970s, the government began to devote more attention to rice production. Indonesia was routinely the largest importer in the world markets during the second half of the 1970s, often accounting for zo percent or more of world trade. The country's dependence on imports was aggravated by production shortfalls stemming from the widespread infestation of the brown planthopper from ₁₉₇6 to 1978.

As Indonesia absorbed increasingly larger shares of the world market, policymakers reassessed the desirability of subsidizing rice imports, which was necessary because domestic wholesale rice prices were held by policy at levels lower than world prices. This policy of setting low domestic rice prices was gradually superseded by the government's desire to promote growth of rice output for long-run food security. Relative to world prices, domestic prices were increased steadily during the last half of the 1970s. When world rice prices fell in the ig8os (see Chapter 3), Indonesian price levels consistently were held above the low world prices. After the world price recovered in 1987 and early 1988, prices in Indonesia were raised too. Several influences undoubtedly entered into the government's decision to raise average domestic rice prices relative to the world price: many rice consumers were less in need of subsidized rice prices following two decades of high income growth; a package of Green Revolution innovations (detailed below) was available and could be spread more rapidly under a positive price environment; and the government had adequate budgetary resources to support agricultural development.

Rice Price Stabilization Policy

A domestic buffer stock, intended to achieve stable rice prices and thereby enhance food security, was introduced in 1974 and has been implemented successfully by the National Food Logistics Agency (BULOG) since that time (Falcon et al. _1985). BULOG defends a floor price to farmers by offering to buy paddy at the village cooperative (KUD) level at the announced floor price, storing purchased grain in government warehouses, and selling rice from stocks when the wholesale price approaches the desired ceiling level. The band between the floor price and the urban retail price is kept large enough to allow for active private participation in the storage and distribution of rice. Reducing the marketing margin to meet the conflicting short-run objectives of low urban prices and adequate incentives to farmers would result in undesirably high storage and administrative costs for the government. BULOG generally has been successful in maintaining a sufficiently wide band to encourage private trade; the agency's procurement of rice has never exceeded ₁₂ percent of total production, and its distribution has been limited to no more than ₁₅ percent of total consumption.

A shift in the ceiling price policy in the early _198os helped to lower administrative and storage costs for BULOG. A single urban ceiling price is no longer officially announced, and the government allows retail prices in the outer islands (in areas without surplus rice production) to rise somewhat above retail prices on Java. The retail price differential between regions has provided greater incentives for private traders to purchase and distribute rice from surplus to deficit regions.

The wholesale price has rarely fallen beneath the announced floor price, with a notable exception in _1985. BULOG has held enough stocks to last three to four months and has varied its purchases of imports (BULOG has an import monopoly) to keep the buffer stock at desired levels. Trade and public stock data are shown in Table _2.4. Generally, BULOG has been able to defend the official floor price successfully.

Fertilizer Subsidy Policy

Much of Indonesia's success in expanding its rice production is attributable to a combination of output and input price policies that improved the profitability of rice cultivation. Since _1968, the prices of virtually all inputs in rice production, except land, animal power, and farm labor, have been influenced directly by government policy. The costs of seeds, water, fertilizer, pesticides, fuel, and machinery have been reduced at various times by specific price or credit subsidies. The subsidy on fertilizer, in particular, has been a key policy tool in Indonesian rice price policy. Timmer ₍₁₉₈₅₎ estimates that as much as one-half of the growth in rice production from ₁₉₆₈ to ₁₉₈₄ was attributed to improved incentives to farmers created by the fertilizer subsidy and stable rice prices.

The wholesale price of rice and the paddy support price have not risen significantly in real terms during the past twenty years (deflated either by the consumer price index or the GDP deflator). But this constant real rice price gave strong encouragement to increase production because new technology caused real production costs to decline. Input subsidies reduced the costs of the new technology even further. When the paddy support price is measured relative to the subsidized domestic fertilizer price, the change over time has been considerable (see Table 2.1). Since 1968, the government has set the price of urea at the wholesale level and has allowed private traders as well as village cooperatives to distribute urea to farmers. Quantities available for distribution are not restricted. To ensure adequate supplies, large public investments in domestic manufacturing plants for fertilizer were made in the mid_-1970s.

Table 2.1 shows that significant incentives to farmers began after 1977, when the ratio of paddy to urea prices was held consistently above 1. o, rising to almost 2.o in 1982. Nominal prices for urea were held constant at RP 70 per kilogram from 1976 to 1982 and were raised to Rp go per kilogram in 1983 and 1984. Since 1985, the urea price has been increased (to Rp loo per kilogram in 1985, Rp 125 in 1986 and 1987, Rp 135 in 1988, Rp 165 in 1989, and Rp 185 in 199o) in order to reduce the size of the budget subsidy. Officially reported expenditures on the fertilizer subsidy

as a proportion of total development expenditures peaked at over 7 percent in 1984-85, when the fertilizer subsidy was RP 732 billion. The continuing need for these subsidies is a matter of considerable controversy, both analytically and in policy discussions.

Public Investment Policy in Rice Production

The near doubling of average rice yields between 1968 and 1989, shown in Table 2.1, resulted mostly from the widespread adoption of high-yielding varieties that were developed jointly by researchers at the International Rice Research Institute (IRRI) and at Indonesian rice research stations. HYVs were first released in 1967 and disseminated throughout Indonesia as part of the Ministry of Agriculture's BIMAS (mass guidance) research and extension program. The technology package supporting the adoption of HYVs included input recommendations, subsidized credit, and the availability of subsidized fertilizer and pesticides. The BIMAS program was an important ingredient of rice development policy in the 197os but declined in the 1g8os after most farmers adopted HYVs and were capable of funding inputs from rice profits.

The initial adoption rate of HYVs was rapid and reached one-third of irrigated area by 1974. Subsequent infestations of the brown planthopper decreased the rate of adoption in the mid_-1970s, but the development of a new seed variety resistant to the predominant strain of the brown planthopper (biotype 2) raised the HYV adoption rate again after ₁977.

Pesticide use by rice farmers increased rapidly, but with very mixed results. By the mid-198os, farmers paid only ₁₀ to 20 percent of the world price for the most widely used brands. The heavy, subsidy-induced use of several pesticides, especially Diazinon, however, killed the natural predators of planthoppers. The hazards to human health of pesticides were also becoming clearer by the mid-1g8os, as were certain financial irregularities within the pesticide program itself. As a consequence, the pesticide subsidy was removed in 1988, and major _efforts were made to install a system of integrated pest management. The changed focus received positive reactions throughout the world. The integrated system is new and incompletely tested, however, and pests likely will continue to be an intermittent deterrent to rice production in the 19gos.

The development and dissemination of new seed varieties are critical to the success of integrated pest management and the continued expansion of rice output. Since the 195os, thousands of local varieties of rice have been replaced by a few rice varieties that are closely related genetically. In the mid-ig8os, two rice varieties (IR 36 and Cisadane) accounted for over one-half of the seeds planted in Indonesia's wetlands. The relatively narrow genetic base embodied in these varieties significantly increases their susceptibility to widespread pest infestation.

Varietal research continues at IRRI and in Indonesia.

Expenditures on agricultural research in Indonesia have been increased gradually during the _ig8os from 3 to nearly 4 percent of agricultural GDP as external aid donors have replaced the declining levels of spending by the Indonesian government (Neste] _1987). Even with increased expenditure, however, the future for new varietal breakthroughs is sobering. There has not been a fundamental breakthrough in experimental yields for twenty years, and the variety _{IR 8} still sets the yield standard throughout Asia. Progress continues to be made via improved yield stability from resistance to pests and drought, but Indonesia is already on the research frontier with respect to germplasm for many of its irrigated farming systems. Unless there are unexpected contributions from genetic engineering, yield increases during the _{iggos will} probably be much more difficult to attain than those in the _1970s and _ig8os.

The dissemination of advanced rice technologies has been facilitated by investments in marketing infrastructure (roads and ports) and irrigation systems, especially on Java. Investments in irrigation have been particularly critical to achieving success in the adoption of HYVs because the new seed varieties were specifically adapted for irrigated systems. Data indicating the amounts of new and rehabilitated irrigated areas resulting from public investment are presented in Table _2.5. Lowland areas with existing irrigation systems, including many regions on Java, were favored by the

initial investments in irrigation between 1968 and 1975. That pattern was reversed in later years, when irrigation investment shifted to less productive rice regions, mainly in the outer islands.

The additions to irrigated area, shown in Table _2.5, indicate a marked decline in investment in irrigation and expansion in area during the early ig8os. Additions to irrigated area, including both rehabilitated and new areas, were only about half as large in the mid-ig8os as they were in the late ₁97₀s and early ig8os. This pattern of reduced public spending on irrigation resulted from a fall in the total development budget and a decline in the share of that budget devoted to agricultural investment. As shown in Table 2.6, the total real (deflated) development budget reached a peak in 1983-84 and fell to two-thirds of that level three years later, after the oil price decline. Meanwhile, the share of the development budget spent on agriculture (including irrigation) dropped to iz to i5 percent in the mid-ig8os after being double that portion in the mid-1970s. This investment pattern was in the process of being reversed in the late ig8os. Such a reversal, both in total agricultural investment and attention given to improved maintenance of irrigation systems, could have a significant impact on the government's ability to carry out its future rice strategy.

Macroeconomic Policies Affecting Rice Production

Macroeconomic policies, defined in Chapter 1, have had little impact on rice production. Although macro

policy cannot provide specific assistance to agricultural production, it could offer positive or negative incentives (even if they were unintended). For example, an overvalued exchange rate would tax most agricultural producers implicitly by causing them to receive too few rupiahs when they sell their commodities (as exports or import substitutes) because the exchange rate is maintained by government policy at an inappropriately low level (i.e., too few rupiahs per unit of foreign exchange).

The history of Indonesian exchange rate policy in the _1970s and early _198os generally is impressive. Periods of overvaluation, caused mainly by insufficient depreciation of the rupiah (i.e., not enough fully to offset faster Indonesian inflation relative to the inflation rates in major trading partner countries), were followed by large devaluations in November _1978, March _1983, and September _1986. A major reason for the two most recent devaluations was the decline in Indonesia's export prices, especially of petroleum. Although there were periods in which agriculture was taxed by overvalued exchange rates, neither exchange rate policy nor other macro policies had a consistently large detrimental impact on agricultural incentives.

Even when the exchange rate was overvalued, the impact on rice production was negligible. As explained earlier in this chapter, the prices of rice and fertilizers are set by government policy and supported by quantitative restrictions on imports or exports. Consequently, rice farmers are insulated against any taxing effects of overvalued exchange rates because the prices of their output and main tradable input (fertilizer) are determined by commodity policies irrespective of world prices and the exchange rate. For these reasons, macro policy is not an important element of rice policy in Indonesia. Of course, budgetary stringency resulting from the oil price decline has a very significant indirect impact on the rice sector by limiting the availability of public investment funds for agriculture. This important constraint is considered above as part of investment policy.

Crop Regulatory Policy

Crop regulatory policy consists of programs or regulations that control the area farmers are permitted to plant to particular crops (Tabor et al. _1988). It also includes a set of less codified pressures that the government is able to bring to bear on farmers through a system of decentralized governance that reaches from the capital to the most remote villages. For example, the hectarage in rice is reduced relative to what it would be if farmers were free to exercise complete freedom in selecting their crop mixes and rotations because government programs force production of sugarcane and tobacco on farms that otherwise could grow more profitable rice. These area regulations are discussed in Chapters 4 and ₇ in the context of analyzing crop substitutions and policies that limit their applicability.

To ensure that targeted areas are planted, the government selects villages for inclusion in the programs on a rotating basis. Rice farmers in the selected villages are then forced to devote one-third or one-half of their irrigated land to sugarcane or tobacco. These programs, which rarely occur together in the same village, are most developed in East and Central Java. Changes in these regulations could lead to significant increases in rice output, as the analysis of alternative rice strategies in Chapter 7 indicates.

Conclusion

Indonesia has experienced a successful Green Revolution in rice production in large part because the government blended price level, price stabilization, and public investment policies to provide positive incentives for expanded rice output. Macroeconomic policy has not been a major negative or positive element because fixed prices for rice and fertilizer have largely insulated rice farmers from exchange rate policy. Crop regulatory policy has had an inimical influence on rice production by restricting the ability of some farmers to plant as much rice as they would like.

Although increases in rice output have been impressive, maintaining a balance between rice production and consumption remains at the fore-front of the policy agenda. What policy options are now available to the government, given that domestic rice prices are aligned with world prices and investment funds for rice are limited by the oil-induced budgetary stringency? Would policies that continue to attract resources into rice production lead to significant increases in rice output, efficient income growth, and rural-based employment? Are there important trade-offs among the objectives of food security, efficiency, and income distribution within the available rice strategies? These issues are at the heart of the empirical investigations reported in the second and third parts of this study.

1

C. Peter Timmer recently summarized his own work as well as that of others in an analysis of two decades of Indonesian food policy; see his "Indonesia: Transition from Food Importer to Exporter," in Sicular, ed. (1989), pp. 22-6^. That essay also has a complete bibliography (pp. 61-62), which includes references to important earlier articles on the Indonesian rice economy such as Afiff and Timmer (1971), and Afiff, Falcon, and Timmer (ig8o). Readers who wish to compare Indonesia's rice policy with those of other Asian countries are encouraged to consult Sicular, ed. (1989) and Barker, Herdt, and Rose (1985).