Camilo Gomez Osorio, Dwi Endah Abriningrum, Enrique Blanco Armas, and Muhammad Firdaus (2011). World Bank Polity Research Working Paper 5758, August.

This article argues that Indonesia's fertilizer subsidy program is not the optimal policy for small farmers or for agricultural productivity in general.

Fertilizer subsidies have been an important part of Indonesia's agricultural development strategy.  In 2008, Indonesia allocated over half of public agricultural spending to seed, credit, fertilizer, and rice subsidies.  At IDR 15 trillion, spending on fertilizer subsidies was nearly double the budget for the Ministry of Agriculture.  The formal goal of the subsidy program is twofold: to increase agricultural productivity and food security and to improve farmers' facility in fertilizer use.  In addition to these formal goals, the authors report that “there is also a sense that the program is a tool to achieve broader goals, ascribing to the program the objectives of maintaining farmers' welfare, poverty alleviation or a price stabilizer” (4).  The subsidy program is intimately tied to the goal of self sufficiency in rice production which remains a priority for Indonesian policymakers.

In this paper, Osorio et al. seek to investigate who benefits from the current system of fertilizer subsidies in Indonesia and how abolishment of the subsidy program would affect rice production.  The data for the study is drawn from two surveys.  The 2003 Agricultural Census surveys 46,000 rice farmers in 29 provinces.  The 2008 Rice Household Survey covered 11,000 farmers in the 15 major rice provinces.

The fertilizer industry in Indonesia primarily produces urea and to some degree compound fertilizers such as SP-36.  Production is monopolized by a state-owned holding company, PT Agro Kimia Indonesia, which includes five companies.  Of these, PT PKT and PT Pusri produce three quarters of Indonesia's urea.  Each company is responsible for supplying several provinces.  Part of the reason why single compound fertilizers dominate the market is that subsidies artificially decrease the price of these relative to mixed-compound fertilizers, where the private sector could potentially do well.  Overall, the Indonesian fertilizer market is characterized by monopoly, low competition, regional segmentation, distortionary subsidies, and underinvestment.  The authors report that “The government objective of ensuring wide access to fertilizer at affordable prices is only partially fulfilled.  There are widespread complaints of fertilizer shortages, particularly as the planting season nears” (5).  Domestic demand has grown at around 5 percent per year over the past decade. 

Several interesting results emerge from the surveys studied.  First, small farmers tend to use more fertilizer per hectare.  In 2007, small rice farmers used twice as much urea per hectare as large farmers, and achieved better yields.  The authors note, however, that this result might be due to the distortionary effect of subsidies.  Small farmers may substitute subsidized urea for other fertilizer or better seeds, whereas larger farmers may be able to afford a more optimal mix of inputs.  This argument is supported by the jump in demand for non-urea fertilizers after the removal of subsidies in 1999-2001.

The authors also conclude that “Public spending to subsidize urea is regressive and a large share of the benefits is captured by the larger farmers” (9).  Larger farmers use more fertilizer in total, with the largest 40% of farmers capturing 60% of the total subsidy in both the 2003 and 2007 survey rounds.  In addition, the largest farmers achieved average rice gross revenues that that were seven times larger than those of the smallest farmers.  Sensitivity analysis indicates that this distribution would not change if the market price of urea were to increase or decrease 10%.  Two stage least squares analysis also shows that the impact of urea use varies geographically.  A 1% increase in urea use increases yields for 0.31-0.49% on Java but only 0.16% elsewhere. 

Overall, the authors report that “fertilizer subsidies have a positive impact on fertilizer use and rice yields, but they do so at a very high cost. Also, while the larger farmers are capturing the majority of the subsidies this assistance has the smallest impact on yields compared with other farmers’ groups. A reform that reduces or removes the fertilizer subsidy would have to take into account these tradeoffs, as well as the fact that smaller farmers are usually credit-constrained and their urea usage is a greater determinant of output. A reduction in subsidies could then be combined with assistance in the form of cash transfers to allow credit constrained farmers to buy an optimal volume of inputs” (18).

The authors conclude that “Although there are circumstances under which subsidies can lead to efficient outcomes, by addressing market constraints, we argue that this is not the case in Indonesia. In addition, in light of limited fiscal resources, there is a trade-off between providing subsidies for private inputs and the provision of public goods and services. As such, the Government of Indonesia is spending large amounts on fertilizer subsidies at the expense of providing support in other areas that may matter more to farmers and the agriculture sector in general” (23).

In particular, the Government of Indonesia should focus on the provision of agricultural public goods with higher returns, such as irrigation, extension services, agricultural marketing in the outer islands, and research and development.  Targeted cash transfers to small farmers would also be more developmentally effective than fertilizer subsidies, as transfers would allow farmers to optimize their input choices.  Lastly, deregulation of the fertilizer industry would promote competition and the quality and availability of fertilizers.