the efficiency and competitiveness of na-oogst tobacco and rice

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THE EFFICIENCY AND COMPETITIVENESS OF NA-OOGST TOBACCO AND RICE PRODUCTION IN JEMBER REGENCY Rudi Hartadi, SP., MSi Social Economic Department Faculty of Agriculture, University of Jember August 2003

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Page 1: THE EFFICIENCY AND COMPETITIVENESS OF NA-OOGST TOBACCO AND RICE

THE EFFICIENCY AND COMPETITIVENESS OF NA-OOGST TOBACCO AND RICE PRODUCTION IN JEMBER REGENCY

Rudi Hartadi, SP., MSi

Social Economic Department Faculty of Agriculture, University of Jember

August 2003

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TABLE OF CONTENTS

SUMMARY ............................................................................................................................................ 3 I. INTRODUCTION .............................................................................................................................. 4 1.1. Background ...................................................................................................................................... 4 1.2. Objectives.......................................................................................................................................... 5 II. RESEARCH METHODOLOGY .................................................................................................... 5 2.1. Location and Time of the Research.................................................................................................. 5 2.2. Data and Sources of Data ................................................................................................................. 5 2.3. Sampling Method ............................................................................................................................. 5 2.4. Method of Analysis .......................................................................................................................... 6 III. RESULTS OF ANALYSIS ............................................................................................................. 6 3.1. General Description of the Research Area ....................................................................................... 6 3.2. PAM Results .................................................................................................................................... 7

3.2.1. Private and Social Profits .....................................................................................7 3.2.2. Analysis of the Efficiency and Competitiveness of Bes-No Tobacco and Rice ..8 3.2.3. Government Policy ...............................................................................................8

3.3. Implications of Results................................................................................................................... 12 IV. CONCLUSIONS AND RECOMMENDATIONS....................................................................... 13 4.1. Conclusions .................................................................................................................................... 13 4.2. Recommendations .......................................................................................................................... 13 BIBLIOGRAPHY ................................................................................................................................ 14

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Summary

Tobacco (Nicotiana tabacum L.) is a plantation commodity that pays high taxes, earns foreign exchange, and employs many workers who earn relatively high incomes. In Indonesia, Voor-Oogst (VO) tobacco is used in producing cigarettes without cigar flavoring and clove cigarettes. Na-Oogst (NO) tobacco is the main material for making big cheroots, cigarillos, and chewing tobacco (Santoso, 1991).

As well as showing a downward trend, Bes-No tobacco prices continue to fluctuate

substantially. The world market is quite thin, and a small percentage of over- or under-supply creates large percentage changes in price. This high degree of uncertainty has led to proposals for regulations by the Jember Government that would reduce the tobacco area.

The PAM analysis shows that even at reduced prices, tobacco is privately and socially

more profitable than the next best alternative, rice. Hence, even though rice is an important food staple, it would not be good public policy to restrict tobacco acreage. The government would perform a useful function if it assisted growers in organizing cooperatives that could negotiate prices with tobacco exporters. Providing information about the situation in international tobacco markets at the time farmers are deciding what to plant, would also be a useful government function.

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I. INTRODUCTION

1.1. Background

Tobacco (Nicotiana tabacum L.) is a plantation commodity that pays high taxes, earns foreign exchange, and employs many workers who earn relatively high incomes. In Indonesia, Voor-Oogst (VO) tobacco is used in producing cigarettes without cigar flavoring and clove cigarettes. Na-Oogst (NO) tobacco is the main material for making big cheroots, cigarillos, and chewing tobacco (Santoso, 1991).

Cheroot (NO) tobacco is produced in three places – North Sumatra (Deli tobacco), Klaten, Central Java (Vorstenlanden tobacco), and Jember (Na-Oogst and Bes-No tobacco). Indonesian cheroot tobacco is needed by the local market to make a cheroot having a traditional taste. It cannot be replaced by tobacco from other countries. A cheroot needs dekblad (bandage), mostly from Deli tobacco, and Omblad (wrapper) as well as filler from Besuki Na-Oogst. These tobaccos can only be produced in two main regions in Indonesia – Deli in North Sumatra and Jember (ex-Besuki regency) in East Java.

Besuki Na-Oogst (Bes-No) tobacco in Jember provided 1.69 % of Jember District’s

Gross Regional Domestic Product. However, in recent years, the demand for tobacco has declined globally and Bes-No tobacco has declined accordingly. There is an increasing worldwide understanding of the dangers of smoking. Because more than 90 percent of Bes-No is exported, there has been a significant decline in the foreign exchange earned from cheroot tobacco.

As well as showing a downward trend, Bes-No tobacco prices continue to fluctuate substantially. The world market is quite thin, and small percentages of over- or under-supply create large percentage changes in price. This high degree of uncertainty has led to proposals for the regulation of tobacco production by the Jember Government.

The market for Bes-No tobacco is characterized by relatively few buyers, i.e, 16 exporters (based on data published by the Jember Tobacco Institute). Each exporter has a trading arrangement with buyers in the importing countries. Exporters are subject to quantity and quality quotas set by those foreign buyers. Few Indonesians consume cigars, so it is not possible for farmers to sell the tobacco in the domestic market. The only market destinations are warehouses that have a particular connection with the cigar tobacco exporters. Farmers have no ability (e.g., technology) to further treat the product, and prices may be as low as Rp. 3,500 per kg.

To avoid the over-abundance of production that produces significant price declines, the

plantation service of Jember Regency has proposed a regional policy to limit the area planted to tobacco and has called for farmers to make alliances with tobacco processing companies and warehouses. Although UU No. 12/1992 states that farmers are free to cultivate whatever

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commodity they wish, as a part of the effort to reduce tobacco acreage, the local government is attempting to persuade farmers to grow rice as an alternative crop.

1.2. Objectives

Two policy questions are raised by this situation. Should the local government restrict Na-Oogst tobacco cultivation area even though the current profitability, although risky, is still greater than that of any other commodity? Are there ways in which the government might create incentives for farmers to substitute tobacco for rice, the less risky staple food crop?

This research will develop an understanding of the economics of producing Bes-No

tobacco and rice, both privately and socially. The results will assist the local government in reaching a decision about the desirability of attempting to regulate tobacco production.

II. RESEARCH METHODOLOGY

2.1. Location and Time of the Research

Research was done in five districts in Jember city – Jenggawah, Ambulu, Wuluhan, Balung, and Rambipuji districts. Fieldwork occurred in September to October 2002. Bes-No tobacco and rice were planted in the dry season (May-August, 2002).

2.2. Sources of Data

Both primary and secondary data were used in the research. The secondary data were from the province, regency, and districts levels. The data from the provincial level were from the Agricultural Department, the Agricultural and Food Commodity Service, and the Plantation Service and Statistical Office. The data from the regency were from the Bappeda, the agriculture service, the tobacco institution, and the statistical office in Jember. The data from the district level were from the district office, agricultural, plantation and farming officials, and PPL (extension workers) in each chosen district .

The primary data were from visits and interviews with farmers, field traders, brokers, and exporters. The interviews were done using questionnaires. There were two types of questionnaires. The questionnaires for the farmers contained questions related to their production activities such as planting, cultivation, harvesting, costs, and income. The questions for field traders, brokers, and exporters contained questions related to the marketing and handling of the commodities.

2.3. Sampling Method

Sampling in this study used a simple random sampling approach. The Bes-No tobacco farmers and rice farmers were chosen randomly. Thirty tobacco farmers and 10 rice farmers were chosen as respondents.

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2.4. Method of Analysis

Data were analyzed using the Policy Analysis Matrix (PAM). The PAM approach measures a commodity’s private and social profits. This information can be used to analyze the competitiveness and the efficiency of commodity systems. The PAM table is described in Table 1.

Table 1. Policy Analysis Matrix (PAM) Table

Cost Profit Revenue Tradable Inputs Domestic Factors

Private cost A B C D=A-B-C Social cost E F G H=E-F-G divergence I=A-E J=B-F K=C-G L=I-J-K=D-H

Source: Eric A. Monke and Scott Pearson, 1989

Explanation: D = private profit H = social profit I = output transfer J = input transfer K = factor transfer L = net transfer

The social costs of tradable inputs can be determined from international prices. Imported commodities use the CIF (cost insurance and freight) cost, while exported commodities use the FOB (free on board) cost. The social costs of nontradable inputs are found by evaluating their social opportunity costs.

III. RESULTS OF ANALYSIS

3.1. General Description of the Research Area

The Regency of Jember covers an area of 3,293,34 km2 . The center and southern part of it are fertile. Jember is surrounded by mountains in the north and east and the Indonesian Ocean in the south. Jember Regency also contains the island of Nusabarong.

For Jember farmers, tobacco is a common commodity. The Dutch developed plantations long before Indonesia got its freedom in 1945. Jember tobacco has unique characteristics and cannot be grown everywhere. Markets in Europe and America favor Jember tobacco, especially the Bes-No variety.

In 2001, Bes-No tobacco was produced in 22 of 33 districts in Jember. The area

planted to Bes-No was 11,807 ha, and production was 13,228 tons. The six most important producing districts were Ambulu, Wuluhan, Ajung, Jenggawah, Balung, and Rambipuji.

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There are three types of tobacco producers in Jember: farmers who produce Besuki

tobacco Voor-Oogst in the north; producers of Besuki Na-Oogst tobacco in the south; and farmers who produce a mixture of tobaccos. These differences are caused by such factors as fertility, capital, risk, and social, economic and cultural considerations.

The south, including the six districts mentioned above, is more fertile than the north,

and the farmers have a higher technical capability. The difference in fertility is caused by a topography that slopes from north to south. People in the north of Jember were the first to grow Bes-No tobacco. Most farmers in the south plant Bes-No tobacco because of the higher soil fertility and skill.

3.2. PAM Results

3.2.1. Private and Social Profits

Profit is the difference between revenue and cost. Private (financial) profits are based on actual market prices accepted and paid by farmers and producers. Government policies, for example, subsidies, taxes, and tariffs, may influence those prices.

If markets are perfect and there are no government policy interventions, private profits

and social profits are the same. In cases where outputs are protected, e.g., rice, private revenues are greater than social revenues and private profits may be greater than social profits. Where inputs are taxed, e.g., fertilizer, private costs are higher than social costs and, other things being equal, private profits are lower than social profits.

The results of the private and social profitability analysis are shown in the PAM

reported in Table 2.

Table 2. Results of the PAM Analyses of Bes-No Tobacco and Rice

Revenue Tradable Domestic Factors Profit* Inputs Labor Capital Total Rice Private 6,792,000 796,920 1,659,865 109,607 1,769,472 4,225,608Social 5,258,423 750,431 1,659,865 91,339 1,751,204 2,756,788Divergences 1,533,577 46,489 0 18,268 18,268 1,468,821

DRC=0.39; PCR=0.30 Bes-No Tobacco Private 12,386,006 2,426,547 3,928,234 370,694 4,298,928 5,660,531Social 13,201,220 2,138,701 3,928,234 308,912 4,237,146 6,825,374Divergences -815,214 287,846 0 61,782 61,782 -1,164,843

DRC=0.38; PCR=0.43 Note: *) Profit is defined as return to management and land

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Based on the cost and returns analysis in private prices, producing Bes-No tobacco, at an average output price of Rp. 12,167/kg), results in a profit of Rp. 5,660,531 per ha per season. (This profit is defined as returns to management and land.)

The high level of private profit from Bes-No is, in part, due to its high yield, 1,018 kg per ha. The output price is also important. The price of Bes-No tobacco was lower when the research was carried out than in the preceding year. This decrease was due primarily to a decline of world tobacco prices and perhaps to a lower quality of Jember tobacco compared to the previous year. Nevertheless, the private profits for tobacco were approximately one-third greater than the private profits for rice.

The social analysis of the cost and returns of tobacco and rice indicate profits of Rp.

6,825,374 per ha and Rp. 2,756,788 per ha, respectively. This large difference is due to the fact that the international price of rice – and therefore rice revenue – is substantially less at social prices than the revenue actually received by Indonesian rice farmers. The divergence is the effect of a tariff of approximately 30 percent imposed by the government on imported rice.

3.2.2. Analysis of the Efficiency and Competitiveness of Bes-No Tobacco and Rice

The Domestic Resource Cost (DRC) is the ratio of the domestic cost of resources used in production to value added. (Value added is the difference between revenue and the cost of tradable inputs – in this case, measured at social prices.) The farming activity is efficient and has a comparative advantage if DRC is less than one (DRC < 1). (Because the social profit is defined as returns to management and land, the cost of land is not included in the computation of the DRC in this study.) The DRCs of Bes-No tobacco and rice show that both commodities are efficient and have a comparative advantage (DRC<1). The value of DRC for Bes-No tobacco (0.38) is slightly less than the DRC for rice (0.39).

The Private Cost Ratio (PCR) is a measure of competitiveness at actual market prices. PCR is the ratio of domestic factor costs to value added in private prices. A PCR less than one (PCR < 1) means that value added in domestic prices is greater than the cost of domestic resources used to produce that income. Both Bes-No tobacco and rice are highly competitive, because the PCR values for both are much less than 1. The value of PCR for Bes-No tobacco is 0.43 and for rice is 0.30.

3.2.3. Government Policy

Government policies in a commodity system can influence producers, consumers, and traders. The influence can be positive or negative. PAM analysis can be used to show how government policy influences a commodity system.

3.2.3.1 Output Transfer Policy and Nominal Protection Coefficient on Output

One of the possible government interventions in a production system is subsidies or taxes on output. This type of intervention can be measured by the Nominal Protection Coefficient (NPCO). The NPCO is the ratio between the output valued at private (actual

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market) prices and output measured in international (efficiency) prices. If the NPCO is more the one, private prices are greater than social (international) prices, i.e., the government is protecting or subsidizing farmers. If the NPCO is less than one, international prices are greater than domestic prices. When NPCO<1, farmers are taxed.

As shown in Table 2, there are output transfers in favor of farmers growing rice and

against those growing Bes-No tobacco. Rice producers receive a higher price than the world price. The tobacco farmers, on the other hand, are getting prices below the import parity price of Bes No tobacco. The output transfer is Rp. 1,553,557 for rice and Rp. (-) 815,214 for Bes-No tobacco. (The value of NPCO for rice is more than 1, i.e., 1.29. The value for tobacco Bes-No is less than 1, i.e., 0.94.) The protection for rice farmers is caused by an import tariff on rice of Rp. 430 kg. Bes-No tobacco producers are taxed by the government (SK Bupati Jember No. 058/2000 introduced a tobacco tax for local government). The main objective of this local government tax is to increase local government revenues.

3.2.3.2 Input Transfer Policy and Nominal Protection Coefficient on Input

Government policy can also affect input prices. The input transfer value is the difference between tradable input costs in private prices (with policy) and social price (without policy). If the input transfer is positive, the policy is increasing private costs over social costs, i.e., farmers are being taxed. If the input transfer is negative, there is subsidy policy on production inputs.

The Nominal Protection Coefficient on Input (NPCI) is used to show whether tradable

inputs are receiving protection or not. If the NPCI is less than 1, farmers are being subsidized. Private costs are less than social costs. An NPCI greater than one means that the private cost of inputs is greater than the social costs, i.e., farmers are being taxed.

The details of PAM result for input transfers used in the calculations of the NPCIs are

shown in Table 3.

Table 3. Tradable Input Transfers of Bes-No Tobacco and Rice

Tradable Inputs Seed Urea TSP KS ZA Pesticides Total Rice

Private 174,074 305,118 99,600 0 63,929 154,200 796,920Social 197,054 289,945 85,038 0 55,034 123,360 750,431

Diverge. -22,980 15,173 14,562 0 8,894 30,840 46,489NPCI = 1.06

Tobacco Private 446,775 551,606 116,460 435,456 72,887 803,363 2,426,547Social 446,775 524,176 99,434 362,880 62,746 642,690 2,138,701

Diverge. 0 27,430 17,026 72,576 10,141 160,673 287,846NPCI = 1.13

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The tradable input transfers for all fertilizers (urea, TSP, ZA and KS) and pesticides for

rice are positive. These positive input transfers are caused by local government taxes. Farmers pay 5 percent taxes for urea, 15-20 percent taxes for fertilizers other than urea due to distribution and trading taxes as well as local government taxes. For pesticides, tradable input transfers are from 20 percent higher because of an import tariff. The only negative value is the tradable input transfer for seed, caused by a government subsidy on rice seed. The total NPCI for rice is 1.06, indicating a small negative effect of government policy on the production of rice.

All tradable input transfers in the Bes-No tobacco system are positive. The value of

the NPCI coefficient is 1.13, which is larger than the NPCI for rice (1.06). Bes-No tobacco farmers, therefore, are more disadvantaged by input taxes than are rice farmers.

3.2.3.3 Domestic Factor Transfer Policy

Inputs used in production can be divided into tradable inputs and domestic factors. Domestic factors are nontradable production inputs (labor, capital, and land) whose prices are determined in domestic factor markets. The divergences between the private (actual) prices paid by the producers for domestic factors and their social prices (opportunity costs) create factor transfers. The factor transfers in Bes-No tobacco and rice production are shown in Table 4.

Table 4. Domestic Factor Transfers of Bes-No Tobacco and Rice

Domestic Factors Labor Capital Total Rice Private 1,659,865 109,607 1,769,472 Social 1,659,865 91,339 1,751,204 Divergences 0 18,268 18,268Bes-No Tobacco Private 3,928,234 370,694 4,298,928 Social 3,928,234 308,912 4,237,146 Divergences 0 61,782 61,782

The factor transfers in both commodity systems are positive. The factor transfers for

both systems are caused by a four percentage point difference between the private and social interest rates. Because there is no UMR (minimum wage rate) or other labor market distortions in the agricultural sector, it was assumed that the private and social costs for labor are equal.

As noted previously, in this study the cost of land was not included in the PAM. Rice

and tobacco are planted on the same type of land and in the same season, and there are large differences in social profits between the two commodities. The use of social profit from one

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to serve as the social opportunity cost of land for the other would have a significant effect on the value of domestic factor divergences and on net profits. The negative net profits earned by rice under this calculation would have meant that rice was inefficient and did not have a comparative advantage on land that can produce tobacco.

However, although tobacco is more profitable than rice and has a comparative advantage in production, the amount of tobacco that can be marketed at a favorable price is very limited. Jember already seems to be producing enough tobacco to fill the contracts that foreign exporters are willing to offer. Using the profit of land planted to tobacco to calculate the opportunity cost of land in a rice PAM would not necessarily be correct because the incremental farmer could not market the additional tobacco at a favorable price. For this reason, in this study the cost of land is excluded from the PAM analysis. The social profit of rice is defined as the returns to management and land.

3.2.3.4 Effective Protection Coefficient Policy

The effective protection coefficient (EPC) is the ratio of value added at private (actual market) prices to value added at social (efficiency) prices. (Value added is the difference between revenue and tradable inputs.) When the value of EPC is greater than 1, the sum of government policies, excluding those affecting domestic resources, subsidizes a commodity system.

Table 5. Effective Protection Coefficient of Bes-No Tobacco and Rice

Revenue Tradable Inputs Rice Private 6,792,000 796,920Social 5,258,423 750,431Divergences 1,533,577 46,489EPC = 1.33 Bes-No Tobacco Private 12,386,006 2,426,547Social 13,201,220 2,138,701Divergences -815,214 287,846EPC= 0.90

The EPC for rice is 1.33. Government policy on rice gives effective protection to rice producers by permitting their costs or profits to be a third higher than they would have been without the policy. Conversely, there is negative protection (a net tax) given by the government to tobacco producers, because the EPC value is 0.90. The costs or profits of tobacco producers are 10 percent less than they would have been in the absence of policy on output and tradable inputs.

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3.2.3.5 Net Transfer Policy and Profitability Coefficient

Net transfers provide a summary of the effect of government policies or market failures on commodity systems. A positive net transfer indicates that incentive policies are being implemented. Conversely, a negative net transfer indicates that farmers have a disincentive to produce the commodity.

The results of the analysis show that the rice system has a positive net transfer value.

Rice producers get an incentive from government policy of Rp. 1,468,821/ha. This net transfer reflects a Profitability Coefficient (PC) of 1.53. Rice farmers receive 53 percent additional profits as a result of government policy.

Table 6. The Profitability Coefficient of Bes-No Tobacco and Rice

Revenue Tradable

Inputs Domestic Factors

Profit

Rice Private 6,792,000 796,920 1,769,472 4,225,608 Social 5,258,423 750,431 1,751,204 2,756,788 Divergences 1,533,577 46,489 18,268 1,468,821 PC=1.53 Bes-No Tobacco Private 12,386,006 2,426,547 4,298,928 5,660,531 Social 13,201,220 2,138,701 4,237,146 6,825,374 Divergences -815,214 287,846 61,782 -1,164,843 PC=0.83

The net transfer for tobacco growers is negative (-Rp. 1,164,843). The Bes-No

tobacco system is discriminated against by government policy. The value of PC (0.83) indicates that tobacco farmers only receive 83 percent of the profit that they would receive in the absence of government policy.

3.3. Implications of Results

The policy issue to which this study is addressed is whether the local government should limit the area under tobacco cultivation and thereby increase the area under rice. The quantitative results obtained from the PAM analysis show that Bes-No tobacco is an efficient and competitive commodity system. It is labor-intensive and uses 2.5 times as many employees per hectare as rice. It contributes more to national income than does rice. Hence, there seems to be no reason for the local government to restrict or limit tobacco cultivation area.

The supply restriction also seems likely to be unworkable. The Jember Government

could not exercise market power in the Bes-No tobacco market, unless the Government also facilitated contractual agreements or strategic partnerships between farmers and exporters.

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Only in that way would the tobacco produced by farmers receive a favorable price from exporters.

IV. CONCLUSIONS AND RECOMMENDATIONS

4.1. Conclusions

Based on the cost and returns analysis in private prices, rice is privately profitable for Jember farmers. However, Bes-No tobacco is even more profitable for farmers who have the type of land and the skills to grow tobacco. The private profitability of rice is significantly enhanced by the government import tariff on rice.

Bes-No tobacco and rice are both socially profitable. The social price of tobacco is

slightly greater than the private price because local governments tax tobacco production. The social price of rice is lower than the private price because the government’s import tariff has the effect of subsidizing farmers by raising the rice price by nearly 30 percent. The DRC of tobacco is 0.56, whereas the DRC of rice is 0.83. DRCs less than one mean that the commodity is being produced efficiently and that it has a comparative advantage in production. Planting tobacco rather than rice creates a more efficient allocation of resources in Jember Regency.

The rice system has a positive net transfer value. Rice producers get Rp. 1,468,821 as

a subsidy from government policy The net transfer for tobacco system is negative (- Rp. 1,164,843). The Bes-No tobacco system is taxed by government policy.

4.2. Recommendations

It does not make sense to have the government restrict the land that farmers can plant to tobacco. Tobacco is the most profitable crop they can grow both privately and socially. The production of tobacco leads to high farmer incomes and an efficient use of regional resources.

With the relatively small and static market, three strategic actions might be taken by

the government: permit Jember farmers to decide what they want to grow; assist the farmers to build a strategic partnership with tobacco buyers, processors, and

exporters, so they would receive the best prices for their tobacco; and provide reliable market information for farmers, particularly before the planting

season, to aid them in their negotiations with tobacco exporters.

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