Abstract
The expansion of oil palm plantation by smallholders in Indonesia is taking place mainly by conversion of forest and arable land. This article aims to understand how institutional arrangements in the supply chain of oil palm fresh fruit bunches (FFB) affect decisions of smallholders to convert more land for oil palm cultivation instead of increasing productivity. Based on an analysis of in-depth interviews with involved actors we find that institutions meant to regulate land conversion are superseded by the structures that govern the transactions in the supply chain of FFB and that this reinforces decisions of smallholders to convert more land. Strategies designed to regulate land conversion need to look carefully at the interactions with the institutions ruling the supply chain of FFB. Institutional innovations such as establishing integrated governance structure from land use to market may induce farmers to focus on increasing productivity.
Keywords
The expansion of oil palm plantations in Indonesia has doubled within the past decade from 3.9 million hectares (ha) in 1999 to 7.8 million ha in 2010 (Directorate General of Estate, 2010). Responding to the increasing demand, the Indonesian government projects a 5.2% growth of palm oil production, reaching 28.4 million tons in 2014, by promoting investment in this sector (Ministry of Agriculture, 2010). Production growth may be attained mainly by expanding the area dedicated for oil palm cultivation and by increasing the yield of palm oil per unit of oil palm plantation area. The expansion of oil palm cultivation in Indonesia and elsewhere has been severely criticized because of its impact on the environment and natural resources (Wicke, Sikkema, Dornburg, & Faaij, 2010).
A share of 42.4% of the total area of oil palm plantations in Indonesia is cultivated by smallholders 1 (Directorate General of Estate, 2010). Within the past decade, the area of smallholders has grown at an average rate of 11.4% per annum. This growth rate is higher than that of private companies (5.4%) and state-owned companies (1.1%) in the sector (Ministry of Agriculture, 2010). Projecting the growth rates of the past few years, the share of the smallholders’ area could surpass the plantation area of private estates (Feintrenie & Levang, 2009).
A dynamic land conversion is taking place and likely to increase because of the expansion of oil palm plantations. Sandker, Suwarno, and Campbell (2007) estimate the loss of about 20% of the primary forest within 40 years in the case of Malinau in Indonesia. They attribute this development to the expansion of oil palm plantations. In the case of independent smallholders, the focus of this article, land conversion includes the conversion of forest as well as arable land (Feintrenie, Chong, & Levang, 2010). The conversion of arable land used before for subsistence crop production has lately ignited a controversial discussion about the impact on food security, increasing poverty, and unequal interhousehold distribution of income (Clancy, 2008; Hultman, Sulle, Ramig, & Sykora-Bodie, 2012; Montefrio & Sonnenfeld, 2011).
The exact contribution of independent smallholders to the growth of the plantation area is not precisely known. Empirical research shows that the area continues to grow (Brockhaus, Obidzinski, Dermawan, Laumonier, & Luttrell, 2012; Feintrenie, Schwarze, & Levang, 2010), while the productivity of smallholders’ plantations continues to be among the lowest (Harsono, Prochnow, Grundmann, Hansen, & Hallmann, 2012; Indonesian Sustainable Palm Oil Commission, 2012). Nevertheless, the practice of extensive production patterns in oil palm plantation predominates among smallholders.
The high returns to land and low labor requirement of oil palm cultivation are given as the main driving factors for the propagation of oil palm plantations in Indonesia (Feintrenie & Levang, 2009; Papenfus, 2000; Rist, Feintrenie, & Levang, 2010). These factors, however, do not sufficiently explain the bias of smallholders toward expanding their plantation areas instead of exploiting the yield potential of the established oil palm plantations. Lack of financial capital to acquire fertilizer is denounced as the main obstacle for intensification in the case of smallholder oil palm plantations in Malaysia (Cramb & Sujang, 2013).
Mandemaker, Bakker, and Stoorvogel (2011, p. 1) found that “countries with a lower quality of governance are more inclined to achieve production increases by expanding agricultural area rather than increasing yields.” The authors suggest that, in order for agricultural production to increase without excessive expansions of agricultural area, governance issues should be resolved. Poor governance in oil palm management, as well as the attitude of local governments to promote oil palm expansion, has contributed to the conversion of forest and arable land in Indonesia (Feintrenie et al., 2010). This observation is in line with the argument of McCarthy, Gillespie, and Zen (2012) that the decentralization of the public administration and decision making has furthered the expansion of oil palm plantations in Indonesia. Cramb and Sujang (2013) confirm that land conversion takes place without control from the government in the case of independent smallholders in Malaysia. The need of improved governance to regulate oil palm expansion in Indonesia is required to halt the forest conversion (Lambin et al., 2013).
An in-depth understanding of the institutional setting in the supply chain of oil palm fresh fruit bunches (FFB) and its implications for land use change is still lacking. The objective of this study is to describe and understand the institutional arrangements in the supply chain of FFB and to assess the connections with the institutional arrangements of land use and land use changes. Furthermore, we seek to understand how both institutional arrangements shape the decision of independent smallholders to give preference to converting forest and arable land into oil palm plantations instead of intensifying the production on the existing plantations.
This article presents the analytical framework, the research method, and the description of study cases. The next two sections constitute Transactions and Institutional Arrangement Related to Land Use and Institutional Arrangement in the Supply Chain of FFB. In the section Interrelated Institutional Arrangements, we highlight the synergies and antagonisms between institutional arrangements in land conversion and the supply chain of FFB. The section comprises a discussion of how the institutional arrangements shape the smallholders’ decision. Finally, in the last section, we draw conclusions and propose alternative institutional settings that could reverse the bias of smallholders to convert land and direct the focus on increasing the productivity of existing oil palm plantations.
Analytical Framework
Our study considers transactions as the basic unit of analysis (Hagedorn, 2008; Williamson, 1985), which is the smallest unit of institutional economics (Commons, 1931). Transactions occur as physical transfer across a technologically separable interface (Williamson, 1985), as well as transfer of rights (Commons, 1931). Based on these concepts, we distinguish transactions taking place in oil palm cultivation, called nature-related transactions (Hagedorn, 2008), from transactions in the supply chain of FFB. The analytical framework can be seen in Figure 1.
Analytical framework
Institutions that mainly operate at the level of institutional environment, regulating human activities within a society, refer to rules of the game (Williamson, 1996). These institutional constraints, either formal or informal, are designed by humans to regulate human interactions and transactions (North, 1990). Transactions should be governed to eliminate conflicts that impede the involved actors to gain mutual benefits (Williamson, 1996). Within an institutional arrangement, bundles of rules are configured according to specific economic purposes that define the duties, the privileges, and the rights of involved actors (Bromley, 2008). How these rules are used appears as governance structure.
We apply the Institutions of Sustainability framework (Hagedorn, 2008; Hagedorn, Arzt, & Ursula, 2002) to structure and analyze transactions and the relationship between them, as well as to understand the role of institutional arrangements in force at the smallholder level. Four groups of determinants are used in the Institutions of Sustainability framework to specify transactions, including the physical properties of transactions, the characteristics of actors, the types of rules, and the governance structures (Hagedorn et al., 2002). The relevant physical attributes include asset specificities, excludability, rivalry, separability, frequency of transactions, uncertainty, and complexity (Furubotn & Richter, 2005; Hagedorn et al., 2002; Shelanski, 1995; Williamson, 1985). Characteristics of actors include the interest, perception, and values that are practiced by smallholders, market participants, and related actors. Institutions or sets of rules consist of formal and informal rules that exist and direct the behavior of smallholders in transactions. The governance structure is designed to enforce these rules (Hagedorn, 2008).
Research Method
The research was conducted in two villages located in the Mandailing Natal district and the Labuhanbatu Utara district in Sumatera Utara, Indonesia. In the Mandailing Natal district, mainly forest areas are converted into oil palm plantations, while in the Labuhanbatu Utara district, mainly arable land, particularly rice fields, is converted for oil palm cultivation. Both types of land resources (i.e., forest and arable land) refer to different property right regimes and institutional arrangements.
The study applies a qualitative approach based on information from in-depth interviews. Respondents were selected purposively according to the snowball principle; that is, information and contact with potential interview partners were obtained through respondents interviewed previously. The main focus groups in the interviews are farmers who grow oil palm. In the text, we also refer to this group of farmers as smallholders. The livelihood of the smallholder families depends primarily on the agricultural goods produced on a farmland area. Currently the area owned by the smallholders is than 5 ha. In the study area with forest conversion for oil palm cultivation, the area oil palm plantations of the smallholders is constantly increasing because of new forest land clearings.
Interviews were conducted with 60 oil palm farmers in both study areas. All interviewed farmers are men responsible for the plantation management within the household. Besides oil palm farmers, interviews were also conducted with rice farmers, rice farmer group leaders, village leaders (kepala desa) and subvillage leaders (kepala dusun), local traders (middlemen), and officials of the Estate Bureau (Dinas Perkebunan) and Agricultural Bureau (Dinas Pertanian) at the district level.
Description of the Study Cases
In the 1980s, concessions for extracting timber from the forest in the Mandailing Natal district were granted to private timber logging companies. Illegal logging and slash-and-burn practices were reported at the time. Documentation of the events includes clear indications that the land clearance was made for the subsequent establishment of plantations. 2 In 2002, the Indonesian government withdrew the logging concessions to the companies, as a reaction to the multiple negative implications of deforestation in the area. Legal issues faced by the companies resulted in the forest area being abandoned.
In 2003, 15 farm families had settled in the former logging area. The influx of new residents to the area continued in subsequent years, and in 2006, the settlement was officially recognized by the local government as a subvillage (dusun). The dynamics of forest conversion for establishing oil palm plantations has gained momentum since then, as villagers seek to clear forest in even more distant and hilly areas.
In the second study area in Labuhanbatu Utara, arable land is being converted into oil palm plantations. Large companies had already started to replace cacao and rubber cultivation with oil palm plantations in the area since the 1990s, a long time before smallholders began growing in the area. At the time, farmers mainly grew food crops (i.e., mainly rice); some of them cultivated cacao and rubber. The area used to be an important supplier of rice in Sumatera Utara. One of the first documented cases of rice field conversion took place in the region. Farmers started to grow oil palm in 1993 in an area of irrigated rice fields. Within a decade, all rice fields had been converted into oil palm plantations. Oil palm cultivation continues to spread among the farmers replacing arable lands.
Of the 150 ha rain-fed rice fields in the studied village, about 90 ha had been converted into oil palm plantations between 2005 and 2010. Rice farmers in the study case were formerly organized in eight farmer groups consisting of 30 members each. Currently, only three groups remain active. Group leaders expressed their concern about the ongoing land conversions. Farmers converting their rice fields to oil palm plantations tend to cancel their membership in the rice farmer groups, which results in a decreasing number of active members in the groups.
Oil palm plantations in the study areas are different in maturity level. Oil palm plantations in the studied village in Mandailing Natal are mainly young and immature, less than 4 years old. Few oil palm plantations in this village have started producing oil palm fruits. Mature and aged oil palm plantations are currently dominant in the studied village in the Labuhanbatu Utara district, ranging in age from 8 to 12 years. Farmers in this village started cultivating oil palm trees earlier than those in Mandailing Natal.
Transactions and Institutional Arrangement Related to Land Use
Physical Attributes of Oil Palm Plantations
Converting land for oil palm plantations involves a relatively high and long-term investment of about 25 years. Preparing new land for the cultivation of oil palm is labor intensive and creates high opportunity costs during the establishment phase of the plantation, especially for smallholders relying on a family labor force (Papenfus, 2000). Once established, the plantation economy proves to be relatively labor extensive compared with the cultivation of annual crops such as rice. The long-term investment in an oil palm plantation implies inelasticity in the use of the land because of the high sunk costs of the investment (Papenfus, 2000; Vermeulen & Goad, 2006). It takes about 4 years until the first harvest is reached. The costs for converting oil palm plantations to other crops are high because of changes in the soil conditions caused by the high consumption of water and soil nutrients of oil palm trees. Our analysis revealed that the interviewed smallholders do not perceive a high financial and economic risk associated with the relatively high initial investment required for oil palm cultivation. This may be because intercropping with annual crops is practiced during the establishment phase of the plantation to compensate income losses in the first years after the conversion to oil palm cultivation. This production pattern can be practiced as long as the leaves of the oil palm trees do not overshadow the land, which is the case 3 to 4 years after the establishment of the plantation.
Oil palm plantations require a low frequency of maintenance once the plantation is established. The labor demand for maintaining oil palm plantations is lower than that of food crop production or other cash crops such as rubber (Feintrenie et al., 2010). This attribute makes oil palm cultivation a labor-extensive activity with high labor productivity. The time of maturity of the oil palm fruit is rather short, which allows the farmers to harvest within 2-week intervals. This ensures a frequent and regular return in cash to the farmers.
These physical properties (i.e., long-term investment, low frequency of maintenance, and short harvesting cycle) add to the eagerness of farmers to convert their land to oil palm plantations. Further institutional factors influencing the farmers’ decision making to convert forest and arable land into palm oil plantations will be analyzed in the following subsections dedicated to the individual case study.
Forest Conversion
The institutional arrangement related to forest use in the studied village in Mandailing Natal reflects the dissent between local people and local government concerning the property right regime of the forest area. Local people claim the forest area as communal property. In contrast, the local government declares that the forest is state property based on the fact that the government had officially declared the forest as logging area some 30 years ago. This controversial issue has not been clarified thus far; even the forest area was categorized as production forests (hutan produksi), according to Law No. 41, in 1999. The officials of the local government point to the Government Act (Peraturan Pemerintah) of the Republic of Indonesia No. 6 established in 2007 concerning forest governance and the arrangement of the planning of forest management and utilization, which states that the government (national, province, or local government) has the authority to manage the forest. This rule refers to Law No. 22 passed in 1999 in which the governance of natural resources is delegated to the local government in the respective region. The farmers continue to convert forest, apparently without restraints, following the local institutional arrangement, and no sanction has been enforced by the local government for the forest clearance thus far.
Besides the local farmers and the local administrators (including the village head and subvillage heads), domestic migrants are actors engaged in the conversion of forest to oil palm plantations. The migrating farmers moved into the area independently, that is, without any support or incentive from the government or elsewhere. The migrating farmers not only come from neighboring subdistricts but also from other regions in the Sumatera Utara province within 140 miles of the village. The migrants have mostly been attracted by mouth-to-mouth information about the possibility to open up the forest in the area. Having low incomes and education levels, most migrants to this village were motivated by the prospect to build a better livelihood.
The respondents indicate that there are no restrictions for access to forest land in the village for either local farmers or migrants. The interviewed farmers expressed no rivalry for forest land at present, except in the case of very advantageous plots with flat land close to the transportation roads, which facilitates the harvest operations and the timely transportation of FFB to the processing sites. Indigenous people have already occupied most of the land close to the village; thus, newcomers have to be content with plots in hilly areas, which are far from the village center and the main road. Competition for forest land among the farmers is expected to increase in the future, as a consequence of population growth in the area.
Any member of the community is allowed to use the forest, including settled migrants registered as members of the community and permanently present in the village. But access to the forest land is not granted to unregistered migrants. Within the community, no one can keep others from expanding their occupied area. These institutions are not designed to prevent an increasing number of farmers and migrants using and converting the forest for oil palm cultivation.
The procedure of registration of domestic migrants as inhabitants is fairly simple. Once registered, the migrants may request a letter of acknowledgment from the village head. It entitles the farmers to the land use rights of the cleared land. This simple procedure should be completed before the clearing activities are performed; however, many farmers apply for this letter afterward. The lacking governance for forest use cannot restrain the growing number of newcomers in the study area.
Having the letter of acknowledgment grants the migrating farmers the right to access, the right to harvest (withdraw), and the right to manage the land, as well as the right to exclude others from the occupied land. The settlers do not have the right to sell the land (alienation). Although selling the land is not allowed, the granted rights are transferred between farmers in exchange for a monetary compensation for the investment made to convert the forest land. This transaction resembles selling and buying of the land. The transfer of granted rights is not limited to the village members. Such a transaction indicates the feature of a private property 3 toward the forest land.
The interviewed persons mentioned that there are no time limits for individuals to use the communal forest land as long as there are no external forces such as land acquisition by the government or investors. However, the use rights are not secured, as the local government does not recognize the rules set in place by the village community concerning the forest use. The ambiguity of the property right regime of the forest to some extent leads to an uncertainty among the oil palm farmers about the persistence of user rights in the future, and may lead to substantial conflicts down the road between the villages and the local government (Feintrenie & Levang, 2011). New actors such as private investors desiring to acquire the land, with power and close ties to the local government, may appear and demand the exclusion of the local population from using the forest in the future. Conflicts like this have become more frequent in Indonesia since the Reformation era in 1998, particularly between smallholders and oil palm companies (Suyanto, 2007). Withdrawal of the local population from the cleared land may be enforced at any time by actors with enough economic and political power. It is doubtful that in this case the letter of acknowledgment issued by the village head is recognized as a proof of rights by the government.
The smallholders in the study area are aware of the implications of this ambiguity for their livelihood. Their attempt to enlarge the plantation area, however, is not affected by the uncertain circumstance. The farmers think that producing more FFB through the expansion of the plantation area will generate more income. They believe this is achievable by using family labor, although they have very limited complementary capital investments. Efforts (i.e., family labor) are devoted to enlarge the plantation rather than to increase the productivity of the existing plantations. In contrast to such thinking, Allen (2000) argues that when property rights are not complete, wealth-maximizing individuals will try to further establish their property rights, and resources will be devoted toward their capture. However, securing the property rights of the occupied land could hardly be achieved by the farmers in these circumstances. In the paradoxical condition where the legally sanctioned structure of property rights (Williamson, 1985) is not properly enforced but at the same time uncertainty is high, the motivation to exploit the land resource (i.e., cutting forest for plantation) is greater.
Arable Land Conversion
The studied village in the Labuhanbatu Utara district has been a transmigration area since 1956. The arable land in the village has been acknowledged as private property for a long time. The property rights of some plots of arable land in the village have not been officially certified yet by the Land Office (Kantor Pertanahan), but all land owners have received a Notification Letter of Tax Due (Surat Pemberitahuan Pajak Terhutang/SPPT). This is an equivalent official confirmation of the full ownership of land, including the legal right to sell or transfer the ownership. In the past, farmers cultivated rice in the swampland, and cassava, cacao, and rubber on the dry land. In the past decade, oil palm has become the predominant crop in terms of area. In 2011, the area of smallholders’ oil palm plantations in the Labuhanbatu Utara district was 67,218 ha, surpassing by far the area of rice fields (37,373 ha; both irrigated and rain-fed rice fields) and rubber (22,341 ha) (BPS-Statistic of Sumatera Utara, 2012). Arable land conversion continuously takes place in the area, and there are no indications for this development to end soon.
Large investments of oil palm companies to establish oil palm plantations in the surrounding areas of the village have exposed the local farming population to oil palm plantations. Nevertheless, our interviewee, the rice farmer group leader, highlights that former rice farmers rarely have sufficient knowledge and skills to cultivate oil palm, especially the selection of quality seedlings and the best practice of fertilizer application. Farmers obtain information and knowledge of oil palm cultivation mainly from other oil palm farmers and relatives who work as day laborers, employees, or foremen for the oil palm companies. However, transfer of information and knowledge among farmers is only partial and incomplete. The lack of capital, incomplete information, and know-how on oil palm cultivation were mentioned as the main reasons for the low performance (i.e., low productivity and low product quality) of smallholders’ oil palm plantations. Apparently, farmers continue maintaining their plantations with low input and no prospects of achieving higher productivities.
Formal rules concerning the preservation of farmland for food production stated in Law No. 41 in 2009 are not enforced in the study area. According to the law, the conversion of arable land that has been assigned and protected for food production is prohibited. In this respect, Labuhanbatu Utara is one of the rice production centers of Sumatera Utara, which means arable land in this district has been used for rice farming for many years. Difficulties to monitor the conversion of scattered plots were mentioned as the main reason for the low enforcement of formal regulations on land conversion. The interviewees mentioned that the actions taken by the Agricultural Office are merely advice through public meetings. It is consistent with the information given by the two group leaders of rice farmer groups in the studied village, who revealed that the prohibition of arable land conversion is merely an appeal rather than a rule. So far, no sanction has been imposed in any case of arable land conversion.
Support from the government granted to the farmers to increase the productivity of food crop production includes technical advice, grants of equipment and machinery such as tractors and rice mills, and input subsidies (e.g., fertilizer and seed). However, these facilities do not halt the farmers from converting their rice fields into oil palm plantations. Cases reported indicate that the subsidized fertilizers granted exclusively for food crop farming are not used for their original purpose and instead are used as fertilizer for oil palm cultivation.
The interviewed farmers stated that once oil palm cultivation has been established on a plot, it is difficult to return to food crop production. They also mentioned negative impacts of oil palm trees on rice plants. Oil palm trees consume much water and lower the groundwater table. Their roots deteriorate the nearby crops and change the soil structure. Further, establishment of an oil palm plantation affects the neighboring rice fields because the roots of the oil palm trees impair the rice fields and rice plants cannot compete with oil palms for the water. In addition, the oil palm leaves block sunlight from the neighboring crops, thus reducing their yields. Finally, oil palm plantations attract rice eaters such as birds and rats. Many interviewed farmers consider the aforementioned negative effects major obstacles to continue with rice cultivation and a decisive argument for converting their rice fields to oil palm plantations.
Although the negative impacts of oil palm production on rice plants are obvious, no consensus exists among rice farmers to prevent the conversion of rice fields into oil palm plantations. Farmers who wish to convert their rice fields into oil palm plantations usually argue that “the land belongs to me” (quoted from the interview with rice farmer group leaders). Rice farmers declared to have suffered losses of production because of the creation of oil palm plantations. However, there is no farmers’ initiative to prevent or regulate the conversion of rice fields. Only a few rice farmer groups are active in this domain, and single farmers are rather defenseless to prosecute or seek compensation for the suffered casualties. In the face of the ongoing land conversions, most of the remaining rice farmers perceive that they have no choice but to turn to oil palm cultivation, too. Meanwhile, the development to convert rice fields to oil palm plantations gains momentum in the study area.
Oil palm plantations have also undermined the mutual assistance system (gotong-royong) that has been an important feature of rice farming in the area. Gotong-royong encourages the rice farmers to make decisions collectively, for example, to organize water allocation and to schedule fertilizer application, pest control, and harvesting. Such institutional arrangements are required, considering the high connectedness among rice fields; however, it is not necessary for oil palm plantations. The informal rules that secured collective decision making in rice cultivation apparently do not affect rice farmers who want to grow oil palm in their rice fields. Hitherto, no informal rules exist to prevent individual farmers from converting their rice fields. The land converted into oil palm plantations is private land, and the rights and duties of private land ownership allow rice farmers to convert their rice fields into oil palm plantations regardless of the impacts on the prevailing land use patterns.
Institutional Arrangement in the Supply Chain of FFB
The types of transactions and institutions encountered in the supply chain of FFB are similar in both study areas. The actors involved in the supply chain of FFB in the study areas include the oil palm farmers, the FFB traders, and the buyers from the palm oil mill companies. The FFB traders can be distinguished into small traders (called local traders) and large traders, namely, the holder of a delivery order (DO; abbreviated DO holder) license. The DO license is an exclusive right granted by the palm oil mill company to a few large traders for delivering FFB to the palm oil mill. The palm oil mill company grants the DO licenses to FFB traders based on bidding or assignment. Local traders can only deliver the FFB bought from farmers to an oil palm mill by showing a DO license from an authorized DO holder. Therefore, affiliation of the local traders with a DO holder is a must.
The number of local traders has been increasing over the past years, most probably as a consequence of the expansion of oil palm cultivation and the rising number of oil palm farmers. There are no formal preconditions to participate in FFB trading as a local trader. The increasing number of local traders has resulted in increased competition among the traders buying FFB from the farmers. The local traders seek to establish a binding agreement with the oil palm farmers that compels the farmers to deliver all the harvested FFB to them. Such agreements are often concluded in the form of an informal (unwritten) contract. An instrument used by local traders to bind oil palm farmers is to grant loans to the farmers at relatively low to zero interest rates. Local traders allow the farmers to amortize over several months. Such loans are also offered by local traders to prospective oil palm farmers. Farmers accepting such attractive loans are obliged to deliver their FFB to the trader facilitating the loan.
Most local traders need to refinance themselves to provide a sufficiently large number of oil palm farmers with loans. The traders acquire refinancing loans from a DO holder operating downstream in the supply chain of the FFB (see Figure 2). Local traders also take loans from DO holders to pay cash to the farmers. The DO holders in turn need reliable FFB suppliers to achieve the purchasing and delivery volume agreed to in contractual obligations with the oil palm mill company. DO holders may face severe sanctions and even the withdrawal of the DO license if they do not fulfill the scope of supply agreed on contractually with the mill company. Therefore, DO holders seek to secure the supply of FFB by giving loans to local traders.
Interplay between institutional arrangements in supply chain of FFB and land use
As a result of the increasing competition among local traders, oil palm farmers cannot be restricted from selling FFB to competing traders, indicating that the agreement is not strongly binding. The only sanction encountered by the farmers in case of a defection is losing the possibility to receive loans once again from the “betrayed” trader. The possibility for oil palm farmers to sell FFB to the local trader with a better offer to buy remains. The excellence of an offer to buy is not only determined by the buying price but also by the willingness of the trader to accept a certain amount of inferior quality of FFB that does not meet the standard of the palm oil mill company. To secure the supply of FFB and increase their trading volume (which is one of the criteria for obtaining a DO license from the palm oil mill company), the traders often agree to buy FFB of inferior quality below the standard required by the palm oil mill (e.g., immature batches). 4 The interviews with traders revealed that the FFB produced by the farmers is diverse in quality. For the traders, dealing with such quality variability implies high costs to minimize rejection of the delivered FFB. Strategies used by FFB traders to avoid the rejection of low-quality FFB are to mix good FFB with inferior-quality FFB and/or to bribe the employees responsible for sorting the FFB at the gate of palm oil mill. Quality control of FFB is mainly effectuated by the employees based on their personal judgment instead of applying monitoring technology.
The oil content of FFB is the main quality criteria applied by palm oil mill companies. The price paid by the mills for the FFB delivered by the DO holders is determined on the basis of the average oil content of all the batches of FFB delivered to the palm oil mill. However, the FFB delivered has to fulfill a minimum quality standard established by the palm oil mill. This standard is followed strictly by palm oil mill companies that produce FFB from their own oil palm plantations. Palm oil mills that do not own oil palm plantations depend on the supply of FFB from smallholders’ plantations to reach the full capacity 5 of the mill in producing crude palm oil. The increasing demand for palm oil and the increasing number of palm oil mills in the area, however, have led to watering down of the quality standards for FFB and have contributed to the selling of low-quality FFB. Depending on the actual supply of FFB, the palm oil mills may be more inclined to accept batches of FFB that do not comply with the quality standards.
Interrelated Institutional Arrangements
The farmers state that the desire or need for cash is the major driver to invest into oil palm cultivation. Oil palm farmers receive the payment for their FFB immediately on the spot in cash. This fact is obviously closely linked to the liquidity of the farmer families and enables them to meet their wants in the short term. The changing patterns of household consumption urge farmers to have cash, and one of the best options to obtain cash inflows is by participating in the palm oil economy.
Even though the insertion in the palm oil economy facilitates the access to loans from the local trader for buying inputs, the farmers are inclined to use the loans for family expenditures. The farmers do not give priority to increasing the yields of their plantations, but favor the conversion of additional forest and arable land if extra capital is available. The high price of fertilizers, the costly maintenance, and the high price of certified seeds are mentioned as constraints for farmers to increase the productivity. For the farmers, having a larger plantation will ensure their income, as oil palm trees keep producing FFB in every specified period, no matter the productivity level of the plantation.
The transactions in the supply chain of FFB are mainly regulated by contracts (i.e., written contract between the FFB trader and palm oil mill and unwritten contracts between the farmer and local trader). Contracts between the DO holders and the mill companies define the quality of delivered FFB. As described in the previous section, DO holders aim to collect as much FFB as possible, even accepting lower quality FFB from local traders to increase their market share. The DO holders speculate that the sorting officers at the palm oil mill accept inferior-quality FFB, either with or without some kind of gratification. In many cases, the DO holders and local traders have to persuade or bribe the sorting officers to accept the FFB of inferior quality. This practice results in a low incentive for oil palm farmers to improve the quality of FFB.
The short cycle of the oil palm harvest (i.e., every 2 weeks) and large volumes of traded FFB lead to frequent and continuous interactions among the actors in the supply chain of FFB. On one hand, the supply of FFB needs to be secured by the middlemen. On the other hand, farmers need the cash. These characteristics of the transactions bring about a strong drive toward the growth of oil palm cultivation, and especially the expansion of the cultivated area. We argue that the reasons for this biased drive can be found in the institutional setting prevailing in the supply chain of FFB.
Institutional arrangements related to land use and market have jointly contributed to the phenomenon of land conversion for oil palm cultivation. In particular, the institutional arrangements of the FFB market have been a major factor shaping the farmers’ decision to convert more land for oil palm cultivation. Figure 2 shows the interrelations among the two institutional arrangements. Transactions that take place in the downstream (i.e., supply chain) greatly influence the transactions in the upstream (i.e., land conversion).
The institutional arrangement concerning land use is closely related to the prevailing property rights regime. In the studied case in the Mandailing Natal district, the forest is, de facto, a common property resource. Against the background of common property resources and an increasing population, Baland and Platteau (1998) state that collective management or the distribution of rights to individuals is essential. In the studied case, no form of collective action among the farmers was found for managing the forest and the land resources. The distributed rights informally acknowledged by the local people are, in fact, not secure. The procedure of designating private property on forest land, as domestic migrants have done (i.e., settling down in the area, establishing plantations, and then requesting a letter of acknowledgment from the village leader), is not legitimately accepted by the official government. So far, no changes in the institutional arrangement for land use and forest management have been made. This may change in the future as a consequence of the increasing competition for forest and land resources. The prevailing institutional arrangement allows forest conversion to continue, possibly, until the land becomes scarce and conflicts for land arise that create high social costs.
In the course of this study, no changes were observed in the institutional arrangement for managing the conversion of rice fields in the study area. The lands are private property in the legal sense. In contrast to the case of the conversion of common property forests, the absence of institutional arrangements in the case of private arable land leads to low or no governance costs because individual actors prefer to carry out one-to-one relationships (Baland & Platteau, 1998). The rice and oil palm farmers manage the problem of externalities (i.e., the negative effects of oil palm plantations to rice plants) with or without intermediation of the village head (kepala desa) or village elder. Individual arrangements facilitate the conversion of arable land into oil palm plantations and allow this development to gain momentum.
The empirical evidence in both study cases indicates that the local population acknowledges and implements informal rules more than formal rules. The formal rules set up by the national or local government are not fully implemented at the local level because the government officials are weak in governing resource use at the farm or field level. Informal rules followed in the study cases do not restrain land conversion, as revealed by the respondents’ answers. Initiatives to establish rules for regulating land conversion have not yet been an issue among local people.
Conclusion and Recommendation
The actual property rights regime of the forest not only offers the opportunity for the farmers to use and to enlarge their plantation area but also generates uncertainty for the farmers regarding their property rights on the land in the future. In the case of arable land conversion, the private property regime does not solve the problem of externalities caused by oil palm trees to rice plants. Cash income and loans are major drivers for the decisions and actions taken by the smallholders concerning land conversion for oil palm cultivation. Our field study results indicate that institutional arrangements of the supply chain of FFB strongly encourages farmers to convert forest and arable land into oil palm plantations. We found that, at present, no restraint for converting land into oil palm plantations has been enforced. Neither the government nor the local leaders and farmer groups regulate land conversions and govern the transactions in the supply chain of FFB.
Following Hagedorn et al. (2002), we conclude that changes in the institutional arrangement would be required and that the institutional arrangement has to be interpreted as a regulative idea, which requires adequate institutions to become effective in various areas of the society. The prevailing institutional arrangements that regulate the palm oil sector in the study areas are, to a large degree, segregated and pay little attention to the problem of land conversion. The rapid development of the FFB supply chain has triggered the expansion of oil palm plantations instead of productivity increases of the existing plantations. As the regions have been developed as big oil palm producers, integrated governance structure for the palm oil sector is required to regulate transactions from land use to market. An outcome of such an institutional change could move the focus of the actors in the supply chain of FFB toward reaching a higher added value by increasing the productivity and quality of the FFB, rather than converting more land into oil palm plantations.
Actors in the supply chain of FFB will most probably adhere to an institutional arrangement that demands compliance with higher quality standards and higher productivities if this results in higher incomes for them. Possible measures within an institutional arrangement that seeks to increase the quality of the FFB include offering bonuses for the delivery of high-quality FFB, linking the award of loans to specific preconditions, and enforcing sanctions to suppliers of low-quality FFB. However, it is unlikely that any arrangement will restrain the delivery of low-quality products and the ongoing land conversion if the distribution of the additional costs and benefit from producing higher quality FFB is not negotiated in a transparent way. Developing governance structures that allow the actors in the supply chain of FFB to have a share and be partakers of the additional value could bring substantial improvements.
Suspending permits for the establishment of new palm oil mills in the area with limited land resources could counteract the drive of land conversions. A smaller number of palm oil mills operating in the area may lead to an increasing competition between the farmers, which may transmit into higher quality awareness along the FFB supply chain. Close monitoring and restrictive practice of authorizing new palm oil processing facilities are preconditions to match the demand for palm oil with the limited natural resources available (including arable land and forest). The kind of governance structures that fit the desired institutional arrangement and the pathway of development toward this institutional setting are inquiries for further research.
Footnotes
Acknowledgments
We express our gratitude to Dr. Flavio Pinto Siabato for his valuable comments on an early draft of this article. We also thank Prof. Dr. Dr. h. c. Konrad Hagedorn, Prof. Daniel Bromley, and colleagues at the Division of Resource Economics, Humboldt University of Berlin for their helpful remarks and advices in the course of the elaboration and discussion of our research at the research colloquium.
Declaration of Conflicting Interests
The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.
Funding
The author(s) disclosed receipt of the following financial support for the research, authorship, and/or publication of this article: The research was financially supported by the German Academic Exchange Service (DAAD) and we received financial support from the International Forestry Resources and Institutions (IFRI) to develop this article.