the social welfare impact of indonesian dairy policies

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The Social WelfareImpact of IndonesianDairy PoliciesErwidodo a & Ray Trewin ba Center for Agro-SocioeconomicResearch , Bogorb Australian National University , BogorPublished online: 10 Feb 2011.

To cite this article: Erwidodo & Ray Trewin (1996) The Social WelfareImpact of Indonesian Dairy Policies, Bulletin of Indonesian EconomicStudies, 32:3, 55-84, DOI: 10.1080/00074919612331337028

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Bulletm of Indonesian Economic Studies Vol32 No 3, December 1996, pp. 55-84

THE SOCIAL WELFARE IMPACT OF INDONESIAN DAIRY POLICIES

Erwidodo

Center for Agro-Socioeconomic Research, Bogor

Ray Trewin'

Australian National University

"he Indonesian dairy sector remains highly regulated, in spite of trade and investment policy reforms elsewhere in the economy. The regulations, aimed mainly at fostering development of local industry, include an impart ratio requirement (BLEEP), import tariffs; an import licensing scheme, and restrictions on investment in milk processing The paper shows that the current policy mix has resulted in a significant increase in numbers of dawy cattle and dairy farmers, and in fresh milk and end-product output. However, this policy mix imposes costs. The analysis indicates that the economy, and m particular dorneshc consumers, would gain if dairy trade and investment restrictions were lessened. The gradual movement towards a more deregulated dairy sector 15 a necessary condition for improved efficiency and a strengthening of Indonesia's competlhve positian in the world dairy market.

INTRODUCTION

Despite recent reforms in trade and investment policies, the Indonesian dairy industry remains subject to tight regulations and trade restrictions aimed primarily at assisting the development of the domestic industry. Four key government regulations affect domestic dairy production: an

'This paper draws in part on papers entitled 'Tndonesmn Dairy Industry: Problems and Alternative Policy Options' by Erwidcdo and Fadhil Hasan (1993), and 'Analysis of Policy Options for the Indonesian Dairy Sector' by Erwidodo and Ray Trewin (1994).

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56 Erwidodo and Ray Trewin

import ratio requirement (BUSEP) in which the quantity of milk imported is dependent on the quantity of domestic milk locally absorbed; an import tariff which ranges between 5 and 30%; import licensing; and restrictions on investing in milk processing.

Theoretically, any trade restriction generally produces inefficiencies and results in net economic losses to society. Some domestic producers benefit while others, and consumers, lose. Objectives other than efficiency, such as distributional and industry development objectives, lie behind the regulations Reforms could redirect the development of the dairy sector towards more efficient arrangements and reduce economic losses to society. However, drastic deregulation could cause substantial disruption and adjustment costs. Careful assessment is therefore needed before any reform is implemented.

Proper assessment of trade and investment restrictions in the Indonesian dairy industry requires information on such areas as the status of dairy farming and processing, and consumption of milk and milk products. This information is taken into a social welfare analysis framework to address relevant questions such as: how protected is the domestic industry? who are the gainers and losers from the current arrangements? and what changes need to take place in these policies?

The paper IS organised as follows. First, background on industry regulations and the development of the Indonesian dairy industry is presented. The theoretical framework for analysis is then laid out and applied to individual policy instruments, grouped in terms of whether they affect mainly milk producers or processors. A concluding section highlights the results of the analysis and the main policy directlons.

BACKGROUND

Major Regulations in the Indonesian Dairy Sector The key government regulations aimed at protecting the Indonesian dairy industry, increasing domestic production and raising the incomes of dairy farmers are as follows.

Import Rationing Policy. This is the most complex of the policy instruments affecting the industry; it is a form ofnon-tariff trade barrier in which the government controls the extent of milk imports on the basis of the quantity of domestic milk purchased by milk manufacturers. Of all the Indonesian dairy policies, it has the most direct impact on domestic milk producers. The current domestic purchase-to-import ratio is 1:2.9, i.e. imports of 2.9 equivalent units of dairy raw materials are allowed for each unit of domestic fresh milk absorbed by the manufacturer. To

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The Social Welfare Impact of Indonesian Dairy Policies 57

import dairy raw materials, the manufacturing firm needs to show 'absorption' certificates or bukti scrap (BUSEP), indicating the volume of domestic milk it has absorbed. This policy instrument is a form of variable import quota aimed at protecting domestic dairy farmers by obligating milk manufacturers to absorb domestically produced fresh milk at 'reasonable' prices. The import ratio is evaluated every six months through a sequence of meehngs:'

a meeting of the milk manufacturers association (IPS, Industri Pengolahan Susu) to estimate imports required to meet market demand after taking into account estimated domestic milk production; a meeting of manufacturers and dairy farmer cooperatives (GKSI) to negotiate import needs based on the GKSI's estimate of domestic milk production; a coordinating team meeting to legalise the negotiated I P X K S I import ratio in the form of a ministerial decree.

Table 1 shows the import ratio from 1980 It declined from 120 in 1980 until the second half of 1990, after which, apart from a dip in 1993-94, it rose steadily from 1.0.5 to reach 1:2.Y at the end of 1995. Production and consumption factors underlying these changes are discussed later. Bearing in mind that the import ratio is renegotiated every six months, it has been suggested that, in principle, once it is set IPS members be allowed to import as much milk as they need in the six- month period, provided they have absorbed all domestic fresh milk production (Erwidodo and Hasan 1993). The current arrangement in fact provides incentives for the various players in these negotiations to exaggerate or under-estimate their needs. The import ratio has been relaxed for some plants in uneconomic locations (Barichello 1987).

F r e h milk pnces are not set directly by government. As the representative of the dairy farmers, the GKSI negotiates fresh milk prices with the TI'S manufacturers. This negotiated price is set, also every six months, by taking into account factors such as the costs of fresh milk production, the costs of handling and distribution, and import

'Even though prices do not appear to play any formal part in these meetings they should undcrlie the supply and demand estimates, especially the latter in the short run. It seem5 to be assumed that pnces move in line with major costs.

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TABLE 1 Ratio of Domestic to Imported Raw Marerials for Mdk Processing in Indonesia, 1980-95

Period Semester Ratio

1980 1982

1983

1984 1985 1987 1988-89 1990

1991

1992 1993

1994 1995

I I1 I

I1

I I1

I I1

I I1

I I1

1:20 1:8 1:7 1:6 1:5 1.3.5 1:2 1.1.7 1:0.7 10.5 10.8 1:1 1:2 1:2 k1.07 11.60 1:1.60 1:2.25 12.9

Source: GKSl(1991), updated

prices (see appendix A for a more detailed discussion of the price formation process under the assumption that the players are operating as a bilateral monopoly). This negotiated price is usually associated with certain quality standards (for example, the percentage of fat or solid non-fat content). Low quality milk is either rejected or subject to price penalties, while superior quality milk attracts price premiums.

The recent agreement in the GATT Uruguay Round has clear implications for a scheme of this nature, requiring Indonesia eventually to convert the protection it offers into an 'equivalent' amount of protection in the form of import tariffs.

Import 'Jflrifs The Indonesian government imposes import duties of 5 to 30% on all dairy products. Raw materials, such as skimmed milk

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The Social Welfare lmpact of Indonesian Dairy Policies 59

powder and anhydrous milk fat, used in producing dairy products are subject to a relatively low import tariff of 5%. while a 30% tariff is imposed on some end-products such as butter and cheese.

1,nport Liccnsinfi m d State Triiding Under the government’s import licensing policy, only designated importers, including state-owned compmes, are permitted to import specific milk products:

PT Panca Niaga is the sole milk importer for the non-milk food industry; PT Kerta Niaga is the sole importer of dairy end-products; and selected milk manufacturers (IPS) are permitted to import raw materials, provided they submit BUSEP certificates.

Import licensing is intended to assist in implementing the government’s import rationing and tariff policies for the industry

R~strictions on 1nzirstinX in Milk Procersinp. In the 1987 list of priorities of the Investment Coordinating Board (BKPM), almost all Indonesian milk processing activities were closed to foreign investment and open to only limited domestic investment (Erwidodo and Hasan 1993). This applied to both existing firms and new entrants. The investment regulation was tightened still further in later years, with all milk processing activities closed to investment of any kind (GATT 1991). Although foreign investment has been freed up in recent deregulation packages, reforms have excluded foreign investment in the dairy sector.

Development of the Indonesian Dairy Industry Milk Production. Indonesian dairy farming IS concentrated in Java. However, incorrect market signals, to a large extent attributable to government intenrention, have led the industry to proliferate in regions where it is neither technically nor economically viable. Table 2 summarises the development of dairy farming in Indonesia behveen 1980 and 1993. Domestic fresh milk production grew significantly during the period, at an average rate of 13% per annum. This was due mainly to the heavy protection and support offered to the industry through government policies. During this period the number of dairy farmers increased from around 13,000 to 74,000 The rise in dairy farmer numbers is larger than that in milk production, suggesting that the number of small dairy farms has increased relative to the number of large dairy farms. There has been a significant rise in the dairy cattle

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60 Envidodo and Ray Trewin

TABLE 2 Development of Dairy Farming in Indonesia, 1980-93

1980 1985 1989 1992 1993

Dairy farmers 12,807 Dairy cattle (000 head) 103

Dairy cooperatives 50 Fresh milk produchon c000 ton@ 77 Fresh milk sales to IPS COO0 tons) 23 Fresh milk prices a t IPS (Rp/litre) 234

Retal fresh milk prices (Rp/lihe) 360

59,524 74,000 74,000 74,100

208 288 312 351 173 190 203 203

201 %a 367 412

148 250 305 325 314 440 532 575

a60 1,500 2,200 2,200

‘Fstimatees are derived from tons of fresh milk sold to IPS using the import mho, under which 3070, 755: and 90% of total fresh milk production was absorbed by IPS ~n 1980, 1987 and 1989-93 respcctwely. Sources. Direktorat Jenderal Peternakan, Statistik Peternakan, Laporan Bulnnan (Bahan R a p i d . various issues, GKSI (1991,1994).

population, from 103,000 head in 1980 to 351,000 in 1993, an annual growth rate of 9% This is due mainly to a special credit program for imported cattle and to a Presidential Support program (Banpres) which distributes cattle to small-scale farmers.

Dairy farming in Indonesia is characterised by its small scale and household nature. Most dairy farms use traditional management practices. As a consequence productivity levels are still very low, around 8-10 litres per cow per day. The income sources of dairy farm households vary according to the scale of their dairy operations, but the incomes of small-scale farmers are usually more diversified than those of medium and large-scale farmers.

Milk Manufacturing. Milk manufacturing establishments may be divided into twm main groups, treatment centres and processing plants. Milk treatment centres process fresh milk from dairy farmers or dairy cooperatives up to the pasteurisation or sterilisation stage only, while milk processing plants also produce higher value added dairy products. In 1993, there were only five milk treatment centres in productlon, all of which were owned by cooperatives and located in major milk producing regions in Java. All milk processing plants were also located in Java.

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Despite restrictions on investment in the milk processing industry, there has been a significant increase in the production of dairy end-products, from 139 thousand tons in 1986 to over 173 thousand tons in 1990. The rising import ratio during the 1990s, in conjunction with increasing domestic production, suggests a growing demand for milk by milk manufacturers.

The Indonesian milk processing industry is very concentrated. In terms of 1990 total sales values, PT FVI (Friesche Vlag Indonesia) was the largest producer, with a market share of 28.3'70, followed by PT FSI (Food Specialities Indonesia) with 22.6%. PT Sarihusada with 15.7% and PT Indomilk with 12.2% The market share of each manufacturer varies according to the type of product, but the level of concentration is, in most cases, higher for individual products than for the industry as a whole (table 3). The high levels of concentration will not have changed much since 1990.

Marketing and Distribution. The marketing and distribution of fresh milk in Indonesia is similar across regions and is essentially dominated by two groups: milk cooperatives and their association (GKSI); and milk manufacturers (IPS). Dairy farms are obliged to sell their fresh milk to their village dairy cooperative. All dairy cooperatives are members of the GKSI, which lays down the rights and obligations of member cooperatives. In terms of marketing, individual cooperatives with 5,000

TABLE 3 Market Shares afMilkManufacturers Bosed on Sales Values. 1990 (%)

Milk Infant Follow-on Full Cream Sweetened Liquid Manufacturer Formula Formula Mik Condensed M t k

Powder Milk

FVI 0.7 0.0 50.8 43.1 0.0 El 24.7 27.1 33.8 6.9 0.0 Sarihusada 46.0 51.1 1.3 0.0 0.0 Indomilk 0.0 0.0 0.0 50.0 75.0 Nutricia Indonesia 8.0 1.6 5.7 0.0 0.0 Other 20.6 20.2 8.4 0 0 25.0 Total 100.0 100.0 1m 0 lm.o 100 0

Some: Calculated from CIC Consultq Group (1991).

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TABLE 4 Farmgate Pflce of Fresh Milk and Marketitlg Costs in Ungnran snd Boyolaii, Ceiitrnl Jaoa. 1991

( R p h t r e j

Ungaran sayolali

Price paid by IPS

Cost for milk treatment and handling (paid to GKSI of dairy cooperatives)

Costs paid to GKSI by milk cooperatives (KUD):

*Cow credit repayment

.Mandatory saving

.Voluntary saving

G K S I >erv~cc fee

*Local lax (swudayo)

*Insurance (KAI)

MIlk retribution to local government

Transportation and handling cost from collection point to milk treatment centres

Overhead costs

Reserved profit at cooperatives

Farmgate price (including transport cost paid to village collector. Rp 5/litre)

"

460 480

24 24

' 2 1

5

29

20

1

3

2

2 1

5a

16 17a

26 17a

5 3a

375 385"

'Average; the figure varies between kecamaian (subdistricts) Sources Ungaran SK Bupati Sernarang (district head's letter of instruction), No. 524 1/0595/1991; Boyolali: SK Bupati hyolali, No. 1137/1991.

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or more litres of milk throughput per day are ?pen the option of selling fresh milk to the GKSI for treatment, or of selling directly to IPS. Each member is bound by the price levels and quality standards negotiated by the GKSI and IPS. Approximately 90% of domestic fresh milk is sent to IPS as input for processed milk, and less than lo"/> consumed directly as pasteurised fresh milk. Thus the share of private- distributors in the markehng of fresh milk is very small.

Local government, both provincial and district (kabupaten) , also plays an important role in marketing fresh milk. The district government sets the farmgate price, marketing and handling costs (including retribution fees to local government), and also formalizes the prices paid by IPS for each standard of milk, based on negotiations between GKSI and IPS. There are no such controls on retail prices. Table 4 sets out the farmgate prices and costs of marketing and distributing fresh milk from dairy farms to IPS in the subdistricts of Boyolali and Ungaran, Central Java. Total marketing costs to the IPS stage in 1991 were eshmated at Rp 85-100 per litre, or approximately 25% of the farmgate price of fresh milk. This appears hgh, and the imposition and level of some of the cost components may be questioned, e.g. reserved profits at cooperahves and retribution fees to local government (each Rp 5 per litre in Boyolali and Ungaran)

M i l k Consumption. Skim milk powder, full cream milk powder, buttermilk, anhydrous milk fat and lactose are the main intermediate dairy products used by Indonesian milk manufacturers. Imports of these products have fluctuated somewhat over the last few years (table 5). The level of concentration of the importers (who correspond to the manufacturers listed in table 3) is high, especially when considered una product basis Of the registered importers, PT FSI was the largest importer of dairy raw materials, followed by PT FVI, with average annual shares of 33 and 21% respectively of the dominant skim milk powder imports in 1989.

Milk remains a luxury good for most Indonesian people and is generally consumed by middle and high income families only. Researchers using Snsenas 1987 data estimated own-price elasticities for milk in Urban/Rural and Java/Off-Java as between -0 62 and -0.78, and total expenditure elasticities as between 0.74 and 1.00 (CARD 1990), though the estimates were much higher for some specific income groups. Per capita consumption of milk remains very low nI'S data indicate that in 1987 it was 2.43 kg per annum for urban families and only 1 kg per annum for rural families In 1993, Susenas estimates of annual per capita consumption were 1.82 kg for urban consumers and 0.69 kg for rural consumers.

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TABLE 5 Imports of Intermediate Products hy Major Registered Importers, 1989 (to,,sP

Milk Manufacturer

FVI

FSI

Foremast

Sarihusada

Indomilk

Panca Niaga

Other

Total

Skim FullCream Milk Milk

Powder Powder

4,178 0 (21.2) (0.0)

(33.0) (0.0)

1,744 0 (8.9) (0.0)

2,870 0 (14.6) (0.01

2,917 0 (14.8) (0.01

0 372 (0.0) (46.2)

1,491 433 (7.6) (53.8)

19,689 804

6489 0

(100) (100)

Butter- Anhydrous Lactose

Fat rmlk Milk

2,830 1,200 99 (64 2) (37.4) (8.4)

577 789 322 (13.1) (24.6) (27.5)

618 400 36 (14 0) (12.5) (3.1)

0 47 378 (0.0) (1.5) (32.3)

0 592 10 (0.01 (18.4) (0.8)

58 182 253 (1.3) (5.7) (21.6)

328 0 72 (7.41 (0.0) (6.2)

(1001 (100) (100) 4,412 3,2W 1,170

'Figures m brackets are percentages. Source: CIC Consulting Group (1991).

ECONOMIC ANALYSIS OF THE EFFECTS OF CURRENT POLICIES

Policy Objectives and Arguments for Trade Restrictions Policy objectives from protection are commonly associated in Indonesia with the three fundamental development goals (tuiloxi). growth, equity and stability. The country's success in achieving rice self-sufficiency has often been used by political leaders to justify the pursuit of the broader objective of food self-sufficiency. It is true that for 25 years the twin

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The Social Welfare Impact of Indonesian Dairy Policiw 65

goals of growth and equity were served well by a development strategy that included the pursuit of rice self-sufficiency. But given Indonesia's current potential as a competitive world milk producer, it could be very costly to extend this policy to include dairy products. Moreover, in contrast with rice farming, which involves the majority of rural people, only a small percentage of Indonesian farmers engage in dairy farming. Heavily protecting this small group at the expense of a much larger group, say dairy consumers, has little justification from either efficiency or income distributional perspectives.

Although trade restrictions usually generate inefficiencies and impose losses on society, a range of arguments are advanced for them: to give protection against dumped products; to nurture infant industries; to protect national interests; to meet balance of payments requirements; and to achieve income redistribution oblectives. The latter argument is probably the most compelling However, there are more efficient means of redistributing income than by altering the returns to factors of production through trade restrictions. These include taxes and subsidies (Kreinin 1983) Trade restrictions pose the risk of rents being captured, with associated efficiency costs, by the more powerful players rather than by those in greatest need. A clear picture is therefore needed of the desired and actual distribution of benefits of the policies before any change in regulations is contemplated.

Social Welfare Analysis of Current Protection A G r a p h m i Representation of the impor t Ratiu and Some Alternate Poiiaes. Figure 1 illustrates the operation of some raw material trade restrictions within a social welfare analysis framework. Domestic supply is drawn, for convenience only, so that Indonesia has no domestic production at world prices. Aggregate supply, S', is a mix of the domestic supply curve Sd and the import supply curve S w . It reflects the given ratio rule (1 part imports to r parts domestic supply), so S* is at l/(r + 1) the distance from Sd down to Sru.

Because of its importance to domestic milk producers and its relative complexity, the representation of the import ratio warrants some detailed discussion. An early representation of the import ratio was given in Ilouck (1986) and another, in terms of consumer prices rather than the producer prices illustrated in figure 1, in Barichello (1987). However, Barichelln had domestic production priced where domestic supply and demand are satisfied. In this case no imports might he demanded (for example, if the own-price demand elashcity was less than unity), yet imports are a key aspect of his analytic discussion.

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f f i Envidodo and Ray Trewin

FIGURE 1 Altnnative Trade Restrictions on Raw Dairy Producl

1 Sd ( T = infinity)

QS Q2 Q, QO

S d = Domestic supply Pd = Domestic producer price

5' = Aggregate supply Pw = Border price of equivalent product

Sm = Worldsupply

Dd = Dometic demand

Q3 = Domestic production at border prices plus tariff

Q2 = Domestic production under import ratio

Qi = Domestic demand at border pricfsplus tariff

Qo = Domestic demand at border prices

pw* = Pw + tariff or domestic price

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The Soctal Welfare lrnmct of Indonesian Dairv Policies 67

From S' it seems possible to determine an aggregate market price and level of output demanded, Pw'and Q, respectively (and hence domestic supply and imports from the import ratio, or vice versa). However, inspection of S' raises a number of questions. Why are continued imports suggested when domestic producer price is around or above the domestic equilibrating price? Barichello's discussion gives insight into such puzzles.

He states (Barichello 1987) that 'because we know the domestic supply curve and the level of local milk demanded, we implicitly know the milk price to domestic farmers (at the plant, not the farm gate). However, this is a separate policy decision as milk policy is currently formulated, leaving open the possibility that the chosen ratio and the price which processors must pay for local milk may not be consistent.' This observation deserves comment. Milk prices to local farmers can be determined from the aggregate market price using the import ratio, and vice versa. Milk pricing is not independently determined by government, but by the same players that determine the ratio. Scenarios chosen by these players that were consistent with market equilibrium could vary from the pairs of high prices/high ratio to low prices/low ratio. It would appear in practice that the players choose an import ratio so that expected demand will be satisfied at the chosen domestic price. The import ratio is not fixed over all possible prices but chosen to equilibrate the market at the chosen price. The aggregate supply c u n ~ S' with fixed r can only be relevant at a point on it where it is expected to cross the demand curve at the chosen domestic price. If prices were expected to be higher than those corresponding to this point then a smaller import ratio should apply, S* should rise and the relevant point should be higher on the demand curve. The relevant supply curve is one that varies with the import ratio r , not one in which r is fixed. In fact, the supply curve will be determined from the domestic supply curve above the domestic equilibrating price ( r infinity), the segment of the demand curve between this price and world prices (0 < r < infinity), and world supply at world prices ( r = 0).

But what if the planned equilibrium is not achieved, say because domestic supply is below or above the expected equilibrium level as a result of climatic conditions? Barichello (1987) states that if it is below the equilibrium level then the value of BUSEP certificates will be bid up, with some processors capturing the rent (and others paying it). If it is above the equilibrium level the excess supply at the farm level is 'somehow controlled' and the domestic supply curve, aggregate supply curve and market price revised upu.ards. Other outcomes are possible, however. If domestic supply is below the equilibrating level at the fixed

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price and processors can import over the ratio to meet demand once all BUSEP certificates have been used, then processors will still capture a rent (and without the possibility of sharing it with producers), but now it will equal the difference in the world and consumer prices multiplied by the extra imports. If domestic supply is above the equilibrating level at the fixed price then a combination of some BUSEP certificates not being used and some excess domestic supply not being taken up will occur. Higher priced domestic production will be used rather than cheaper imports, for example when processors are locked into long-term contacts.

Regional factors are important in this outcome also. Some inland processors will process domestic production and sell their BUSEP certificates if they are in demand, while those close to ports process imports and buy BUSEP certificates when they need them to cover these imports. The size of these effects will depend on the degree to which the planned equilibrium is not achieved and on the subsequent market response. Surplus domestic production finds its way into the market place in some form, or is consumed privately. The means by which the market can adjust could he as important as the initial procedures. An inconsistent representation of the import ratio in terms of domestic and overall quantities and prices could lead to incorrect measures of the social welfare benefits and costs of the policy.

The other raw material trade restrictions and some other relevant policies can also be represented in figure 1 An import tariff raises the border price from Pal to Pm', increasing domestic upp ply and reducing domestic demand by their respective responsiveness to this price increase, the difference being made up by imports. An import quota will have an impact similar in some respects to that of the import tariff, the domestic supply and demand responses being due to price rises from quota rents formed when domestic supply at world prices plus the quota falls short of domestic demand at world prices. A production subsidy results in lower costs of production and hence more supply for a given price. This 'shift in the supply curve to the right' can alternatively he represented m terms of its supply side impact, as an increase in prices received by producers.

Social Welfare Annlysis of the Import Ratio and Some Competing Policies. Social welfare changes are measured by the net effects of changes in producer surplus, consumer surplus and government revenues. Although aspects of the Marshallian concepts of consumer and producer surplus within this framework have been questioned (e.g. weightings given to units of consumer versus producer surplus), on

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The Social Welfare IrnDact of Indonesian Dairy Polides 69

balance there is agreement that they are useful, even if just as a framework for analysis.

Theoretically, import tariffs are generally the next best option after free trade if economic efficiency is the primary concern. However, efficiency may be better served by the current import ratio than by a tariff that was so high as to exclude imports (Erwidodo and Trewin 1994) The import ratio as currently implemented could also be the favoured policy if maximising domestic production at least cost were the primary concern. Instead of eshmatmg the various curves and areas that appear in a series of figures like figure 1, covering all levels of the market (fresh milk, processed milk and final market), as would occur in any formal social welfare analysis of relevant dairy policies at all levels (e.g. Just et al. 1982; Tolley et ui. 1983), we use the analytical framework presented in figure 1 for the raw product market alone to structure descriptions of the impact of the policies. Work currently in progress (Smith r i a l . 1995) links separate social welfare representations of all levels of the Indonesian dairy market.

The welfare changes for an import tariff, an import ratio (BUSEP) and an import quota that result in the same border or overall domestic price Pw', are illustrated in table 6, whose alphabetical symbols refer to elements of figure 1. Because the policies are represented as having the same impact on border or overall domestic prices, they all have the same impact on consumer surplus. The gain to producers under the import ratio policy is b + e; this is greater than the gain of e under a tariff or quota that results in a similar border price. In contrast with import tariffs, the BUSEP scheme has no implications for government revenues or expenditures, and has been described a5 a self-financing tariff/subsidy policy, because the profits processors make from importing milk raw materials under the tariff h are used to subsidise the purchases of domestic milk ( h + c). Where the government does not attempt to capture the quota rents for itself, the import quota also has no implications for government revenues or expenditures. Overall, an import tariff results in the least net social loss and no trade the most.

The import ratio policy assists farmers by fostering domestic fresh milk production and increasing farm incomes It provides farmers with a guarantee that all fresh milk will be absorbed by IPS manufacturers at 'reasonable' prices. As figure 1 shows, with the import ratio policy, Q, of local milk is purchased, whereas with a tariff or quota that results in a similar consumer price (Pm'), only Q, of local milk is purchased.

If the government's objective is to still minimise cosb to society but to foster domestic fresh milk production rather than maintain domestic

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i'+Y+ (I + 4 +S+ S+A- (r+X+/+3)- (!+A- /+p+')- ssqleposia~

plWlUJaAO3 0 a%ueya muahai 0 0 Y+S

,+q=yse (j + y + St/+ a)-io G+Y+

O+Y+ (!+S+ (!+l(+ $+/+a+ 8 +/+a) - /+a + J + q) - 8 +/+a) - p + 3 + 4)- a'Jueq3 sn1dms

d a+q a J + q a8uq snldms

iaurnsuq

iampaij

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effect of the import ratio, but this is compensated for by a higher tariff, possibly leading to much larger gains to processors from the tariff than milk producers receive from their assistance. Milk producers gain from the import ratio, but processors also gain from other policies that restrict competition from imports and new entrants.

TABLE 7 Net Soczal Lass Relative to Free Trade af Palicies MainrainrnX Domcstzc Productiona

Welfare Impart Tariff Import Ratio Producer Changes (PW' - Pw) (domestic producer Subsidy

pnre rw') (PZU' - Pw)

Producer surplus change e e

Consumer surplus change - (e + f + g + h + 0 - ( e + f + part

Government revenue change X + h 0

Net social loss - V + O - fjc part i p

e

o

- @ + D - f

'As for table 6. b'Part i' rcflccts the fact that under the import ratio consumers face a price between Pw* and Pw because of the mix of domestic product with price Pw' and imported product with price Pw

A different analytic framework is required for an overview of the impact of dairy policies on efficiency and equity. Separate social welfare representations of all levels of the market as described above could be linked so long as all the policies can be incorporated in the framework. The welfare changes for the two mainly processing-related policies-import licensing and investment restnctions--cannot easily or fully be incorporated in diagrams like figure 1, though those for import licensing are represented to some extent by the import quota policy. The import licensing policy hds no impact on government revenues, but can involve large and mainly hidden net social losses.

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72 Erwidodo and Rav Trewin

Below we present various measures of the misallocation of resources that results from the assistance structure created by the suite of Indonesian dairy industry policies.

Measuring the Impact of Current Policies Resource Cost Ratios and Coriipnmtiae Advantage. The resource cost ratio is a commonly used indicator of comparative advantage and the need for assistance. This ratio measures whether domestically produced goods have a lower economic cost than their equivalent import or export value. If the ratio is less than one then the country is said to have a comparative advantage in the production of that good given the circumstances at the time (e.g technology, output levels, world prices). Using this ratio, Irawan and Rusastra (1990) concluded that Indonesia did not have any comparative advantage in milk production The ratios for corporate farms ranged from 1.6 to 5.0, while those for small-scale farms ranged from 1.4 to 3.4, the wide range being attributable to differences in cattle breeds, locations and trade regimes.

Using the same analytic tool. SPptiani (1988) computed the ratios for intermediate dairy products (skim milk powder and anhydrous milk fat) from an integrated dairy farm-processing system in Central Java. Both land based and non-land based farming practices, and Australian and US cattle breeds, were assessed. The estimated ratios ranged from 1.5 to 2.1 with assumed productivity of 8-15 litres per cow per day.

The ratios are static measures, and highly sensitive to changes in prices and other determining factors. If world market prices increase as expected following reforms then the estimated ratios could fall substantially. Irawan and Rusastra (1990) concluded that i f dairy product prices at the time ot their analysis increased by 17%, or if fresh milk prices increased by 4R'!i>, then small-scale dairy farming with cross breeds vmuld be economically viable. The corresponding figures for imported breeds are 33 and 64% respectively. Septiani (1988) did similar sensitivity analysis on his intermediate dairy product results, and found that econnmic feasibility would be achieved with a 50% increase in prices, or with an increase in productivity levels to 12-14 litres per cow per day for Australian breeds (a difficult though not impossible target that could be reached through competition resulting from more open trade policies), or at more than 20 litres per cow per day for US breeds.

Rates of Profection and Resource Allocation. The degree of protection can be measured using either the Nominal Rate of Protection (NRP) or the Effective Rate of Protection (ERP). The NRP is the ratic of the difference between the domestic price and the (adjusted) border price of

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The Social Welfare Irnoact of Indonesian Dairy Policies 73

a commodity to its (adjusted) border price, expressed in percentage terms. A positive NRP indicates price protection. The NRP of production inputs is commonly referred to a5 the implicit tariff or tax. The ERP measures the degree to which protection causes actual value added to diverge from the value added that would have prevailed in the absence of protection. In other words, the ERP measures the net effects of protection considering output and all inputs used. A positive ERP implies that production is receiving net positive incentives. Changes in protection that reduce the spread of effective rates are likely to reduce the welfare costs of protection. A number of assumptions underlying these measures suggest that caution should be used in their interpretation. For example, it is assumed that domestic and foreign goods of the same description are perfect substitutes, that there is infinitely elastic supply for a country's imports and infinitely elastic demand for its exports, and that production relationships remain unchanged by the htructure of assistance.

NRPs of fresh milk in Indonesia between 1985 and 1993 were estimated by Erwidodo and Hasan (1993) and are shown in table 8. These fluctuated somewhat, owing mainly to the unstable world market price, but tended to decline. In 1993 the NRP was estimated at 38%, indicating that the average domestic price received by dairy farmers was 38% above the import parity price (the price that would have prevailed in the absence of an import rationing policy). With an import tariff on dairy raw materials of 516 and a domestic/import ratio of roughly 1:l in 1993, the average price of fresh milk paid by manufacturers was 16% above the import parity prices of frwh milk equivalent product. The current final product tariff of 30% is therefore more than enough on the basis of raw material costs to protect domestic milk manufacturers from competihon with imported products.

The estimated NRPs for powdered milk between 1985 and 1993 are presented in table 9. They are very much higher than those of fresh milk-around 134-43% in 1993. They are also much larger than the actual import tariff of 30% This last aspect reflects the monopoly power imparted by the policies of import licensing and restricting investment in milk processing. A further monopoly effect is the increasing gap between fresh milk prices at the IPS level and the retail level (table 2).

A lack of data at the time prevented the calculation of the most recent ERPs in Erwidodo and Hasan (1993). However, some estimates of these, as well as NRPs for 1995, have been calculated by Fane and Condon (199h). For dairy products (Input-Output sector 46), they estimate the

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TABLE 8 Nominal Protectmi Coefficients oJ(Equrva1ent) Fresh Milk in Indones?~, 3985-93

Year Border Price Wholesale/IPS NRP of Equivalent Fnce of ( "1" 1 Frwh Milka Fresh Milkb

1985

1986

1987

1988

1989

1990

1991

1992

1993

204

196

217

234

344

332

392

384

417

300

350

390

400

400

425

460

532

575

47.1

78.6

79 7

70.9

16.3

28.0

17.3

38.2

37.9

'Calculated from the border pnce of full cream mllk powdei (FCMP), using the following technical coefficients: (i) 1 kg of FChlP is cquiralent to 8 litres of fresh milk; ( t i ) the cost of I kg of FCMP is 80"/0 attributable to the costs of fresh milk; (iii) the transportation cost 1s estimated at 2.5% of the bordcr pnce. 'Average price of fresh milk paid by milk manufacturers to GKSI or milk treatment plants

NRP in 1995 as 17%; for milk livestock (1-0 sector 23). they base their ERP estimates on our 1993 NRP of 37.9% (table 8). Their much lower NRF for dairy products is due to the use of different price comparison estimates from those of Erwidodo and Hasan (1993): Fane and Condon use a weighted average of tariffs and surcharges, because the price comparison study they used found no evidence that non-tariff barriers raised domestic prices relative to Singapore prices, which were their benchmark for world prices. In contrast, Erwidodo and Hasan use the difference between domestic and world market prices, adjusted by the exchange rate, 1 ~ ~ 5 a margin for canning and other appropriate costs. At any rate, Fane and Condon estimated the ERP for milk livestock at 92%; their estimated ERP for dairy products was even higher at 99'b. I t is

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76 Erwidodo and Rav Trewm

Computable General Equilibrium (CGE) modelling, which captures the intersectoral linkages between the dairy and other relevant sectors of the economy, and constraints such as those on government budgets, would be an appropriate approach. It would also provide a more realistic picture of the changes in industry structure and social welfare. Although the import ratio was difficult to model directly, some preliminary analysis along these lines was undertaken in Erwidodo and Trewin (1994). This analysis showed that thc economy as a whole gained from across-the-board tariff reform, which lowers costs faced by all industries, particularly export-oriented Industries. A more detailed specification of various welfarc measures would be required for such modelling, to address the industry-specific efficiency and equity questions discussed in the sections on social welfare and rates of protection.

Overview of the Impact of the Policies Economic Inefficimcy. Owing to price signals that do not reflect even distorted world market conditions, fresh milk is being produced in regions where it is not economically viable, and crowding out more viable economic activities. Moreover, quantity is encouraged by the BUSEP policy at the expense of quahty, especially in the new dairy production areas. In traditional milk producing regions such as Pangalengan in West Java and Pujon in East Java, the estimated percentage of poor quality fresh milk is only 3 4 % of total production. Although costly, effective quality control-rejection of low quality produce and premiums for higher quality produce-has gradually induced dairy farmers to provide better quality fresh milk in these regions. Replacing the BUSEP scheme with tariffs’ (with no import licensing restriction) would make regulations more transparent and easier to manage. Although price signals received in the market would still be distorted, the import tariff should not necessarily influence quahty. Replacing the BUSEP scheme with a subsidy would still lead to distorted price signals to frcsh milk producers, but this effect would not be transferred downstrcam to milk manufacturers and other end users of fresh milk.

2The replacement of the BUSEP scheme with tariffs may necessitate the investigation of adjustment options, for example the conversion of BUSEP rights implicit m domestic production to freely hansfcrahlc production quotas, aimed at facilitating more pfficient producers taking over from less efficient producers, but not restricting overall production

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The Social Welfare Irnoact of Indonesian Dairv Polici- 77

In milk man~rfncturing, the average price the manufacturer must pay currently for raw materials is the weighted average of domestic and border prices (plus tariff) based on the domestic/import ratio. Rapid expansion of domestic fresh milk production without technological and productivity improvements will result in high-cost raw materials and a non-competitive milk manufacturing sector. Domestic prices are negotiated mainly on a cost-of-production basis, bearing in mind the constraints of import competition. Cost-of-production pricing fails to provide incentives to lower costs, to increase productivity and to innovate. This practice in Australia delayed the introduction and development of new products such as UHT milk, with its reduced need for refrigeration and speedy marketing. To minimise social losses the domestic price of fresh milk should be closely linked to long-term trends in world prices. Competitiveness in milk manufacturing is also lessened by restrictions on trade in BUSEP certificates, such as the minimum transfer price.

The milk manufacturing sector has its own forms of assistance such as import licensing and investment restrictions. The efficiency effects of import licensing tend to be hidden and may only become evident when industry performance is compared with that of competitors. The allocation of rights and monopoly rents discourages innovation and leads to loss of potential economic efficiency gains. Restrictions on investment hinder the development of a more competitive dairy industry by discouraging new entrants to the industry. Protection for the manufacturing sector may counteract non-competitive features of the domestic fresh milk market, but the long-term future of the Indonesian dairy industry lies in its being internationally competitive in all sectors.

Current policies will not encourage efficiency improvements in milk distribution, such as removal of the unnecessary local government retribution. Local government involvement can inhibit the development of a national approach, which is essential to the industry's competitiveness in the world market. One way to discourage charges such as the local government retribution is to open the market to fair international competition.

The availability and quality of feed is hampered by Indonesia's grains poiicics (Trewin and Tomich 1994), and is considered a major constraint on improvement in dairy production levels (Remenyi 1986).

Equity. High production costs due to the import ratio and other inefficiencies are passed on to consumers, and impact most heavily on those with low incomes; t h s conflicts with other government policies aimed at increasing the nutritional standards of the Indonesian people, especially those of low income groups. Processors, especially those in

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78 Erwidoda and Rav Trewin

highly concentrated segments, gain more from the policy mix than do milk producers

There is a question of who the arrangements should assist. Most dairy milk production occurs in Java where a greater number of alternative income opportunities exist. Similarly, small-scale production, which currently appears the most viable, is less dependent on dairy income than is larger-scale production. A production-based policy is an ineffective means of providing income support to small farmers: most of the assistance goes to large producers, especially those who also have other income opportuluties, such as Javanese farmers A similar problem exists writh some other policy options discussed later, for example production-based subsidies.

Stability. Policies may aim at 'stability' in several senses, from stability in the structure of an industry or in market access to stability in prices or incomes. Stability should be about minimising uncertainty, not, for example, about altering price variations that occur in predictable seasonal patterns. Nor should it he about price support. Income stability is a more justifiable objective than other forms of stability; the import ratio policy can contribute to income stability, though mainly indirectly through its pricing effects. Stabilisation policies invariably involve some trade-off between stabilisation benefits and economic costs. Stabilisation will transfer uncertainty from one group to another, the direction depending on whether the uncertainty comes from demand or production sources For example, if there is uncertainty in demand, stabilisation transfers the uncertainty from producers to consumers. The reverse applies with uncertainty in supply. In an unregulated Indonesian dairy market, most instability would come from the supply side, with price variability acting as a form of insurance for consumers but a source of uncertainty for producers (Jones 1995). Stabilisation would then transfer uncertainty from consumers to producers. Although there would be less need for stabilisation in a larger and less distorted world market, empirical work suggests the need to identify significant sources of uncertainty and to investigate ways of overcoming any failures in private insurance markets without resort to variable tariffs and intervention stocks.

The Need for Reform Protection given to particular sectors of the economy imposes costs on others. Resources are used in an inefficient way, transforming non- protected efficient activities into less efficient ones Insulating the domestic dairy product market from world compehtors also provides no incentives for domestic producers, especially the milk processors who

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now enjoy the greatest benefits, to improve performance and increase efficiency. Reform or deregulation is needed, regardless of GATTT/WTO or other external pressures, to increase the sector's efficiency and reduce economic losses. Gradual reform seems the most appropriate policy choice, to minimise disruption and adjustment costs.

Demand for dairy farm income support is one factor that has led to the current types and levels of dairy protection. There are nthcr ways to narrow the gap between rural incomes and those of the rest of society. Indeed, the research demonstrates that current policy schemes are not a cost-effective means of supporting dairy farmer incomes, and are very costly for the economy as a whole. Dairy production is not the main source of income for Indonesian rural people, and off-farm income will become a larger component of rural incomes as development progresses. Thus policies to promote productivity growth across sectors provide an alternative means of raising rural incomes in the longer term.

A rural growth strategy encompassing a range of agricultural products plus rural non-farm activities will certainly be more complex to implement than the commodity-based development of the past. But its long-term result will be economic growth supported by an efficient agricultural sector that develops according to comparative advaiitage. Moreover, the provisions of the GATT/WTO will limit possible 1ei.els of agricultural protection among member countrieb. Forsaking markets for manufactured exports in order to protect agriculture w.ould be very costly for Indonesia in terms of both growth and equity (Trewin and Tomich 1994).

POLICY DIRECTIONS AND CONCLUSION

The paper has analysed the extensive regulations responsible for the growth of the Indonesian dairy industry, and examined their relationship to world dairy trade. The analysis has shown that some of the policies give significant benefits to producers and processors, but impose large costs on consumers and on the economy as a who!e. There would be substantial gains, in particular to domestic consumers, if some of the trading restrictions imposed by the policies were lessened Future development of the Indonesian dairy industry, especially following the GATT Uruguay Round, will depend on the domestic sector being competihve in a more open world market. Productivity will become more important than industry protection. Deregulation is a necessary condition for increased efficiency and competitiveness of the indusln; in a world market.

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80 Envidado and Ray Trewin

So what changes in policy direction are indicated? The following criteria should be applied in evaluating policy options, particularly from an efficiency perspective:

government intervention should be minimised, and all types of market distorting intervention avoided or gradually removed; effort5 to increase efficiency should be promoted continuously; assistance should be provided only where it is most needed; constraints on resnurce mobility should be minimised, as a rapidly changing world demands flexible arrangements.

Within these guidelines a number of specific policy directions could be followed (not in priority order):

Abolishing the import ratio on fresh milk (as required under the GATT Uruguay Round) hut maintaining high levels of domestic production could be achieved with an import tariff on intermediate dairy products large enough to guarantee high absorption of domestically produced fresh milk, or with a production subsidy. A tariff of 25-30?> is probably sufficient. this rate is almost double the average NRP for equivalent fresh milk of about 17%, hut might be necessary in the short run because imported product may still be preferred to domestic product. If world prices increase with reform under the GATT Uruguay Round, the tariff level required to maintain domestic production would be much lower. Similar observations apply to the production subsidy option. At current world prices and industry productivity levels, a production subsidy of 17% is probably necessary to maintain domestic production. If such a subsidy were introduced it should he considered a short-run means of transferring income to retain producers in the industry (and could be done more equitably on a per capita than on a production basis), while other policies are introduced to raise productivity in the longer run Since high tariffs on raw materials raise the costs of milk manufacturers, compensating tariffs on end-products would also be required to enable the domestic industry to compete with

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imported products. For the above fresh milk tariff levels, raising the current 30% import tariff on end-products to 40% should allow domestic milk processors to compete with world dairy producers. Again, if world prices increase with reform under the GATT Uruguay Round, the tariff level required to maintain domestic production would fall significantly A production subsidy has no downstream pricing effects. Import licensing could be abolished (that is, registered or producer importers could become general importers), or at least the small number of licensed importers could be allowed to attain more equitable levels, particularly in the case of end-products. With the suggested 40% tariff, milk manufacturers should be able to compete with imported product regardless of who the importers are. Restrictions on investment could be removed, and greater equity allowed. Support could be concentrated on small-scale farms in efficient dairy production regions, as these are likely to be more viable over the longer term and assistance more justified on equity grounds. Some extension programs could be expanded, for example a domestic cross-breeding program could be introduced. Efficiency in dairy farming, processing, and distribution and marketing could be increased by, for example, eliminating irrelevant marketing fees. Alternative stability arrangements could be investigated, for example, financial instruments, and targeted research and development ~n areas such as improved milk storage.

*

*

The above are very much 'first best' recommendations. Trade restrictions such as tariffs endorsed by GATT may be imposed on other than efficiency grounds, in particular on income distributional grounds, even though these objectives may be best achieved more directly through budget transfers. Given that processors are the main beneficiaries of the current arrangements, and that current assistance levels are relatively high, any deregulation should first address arrangements that assist processors, such as import licensing and restrictions on investment.

What is required next is detailed analysis of the policy alternatives, including their effects on industry size, efficiency and distribution. The

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82 Envidodo and Rav Trewin

research for this paper has not included such analysis in the necessary detail, b u t work in progress (Smith et al. 1995) is intended to meet this objective.

REFERENCES

Banchello, R.R. (1987). Creative Import Controls: The Case of Milk in Indonesia, Invited paper delivered to 1987 Australian Agricultural Economics Society Annual Conference, University of Adelaide, Adelaldc.

Bohman, M., L. Jarvis and R. Barichello (forthcoming), 'Rent Seeking and International Commodity Agreements. The Case of Coffee', Economic Deuvelopmmt and Cdteral C h q e ,

CARD (Center for Agricultural and Rural Development) (1990). Analysis of Food Crop Policy for Indonesia, CARD, Iowa State Cnwerstty, Iowa (rnirneo)

CIC Consulting Group (1?91), Studi Tentang lndustrt dan Pemasaran Susu di Indonesia, Corinthian lnfopharrna Corpora, Jakarta (rnlmeo)

Erwidodo and F. Hasan (19?3), Indonesian Dairy Industry. Problems and Alternative Policy Options, Center for Policy and Implementation Studies, Jakarta (mimeo).

Erwidodo and R Trewin (1994). Analysis of Policy Options for the Indonesian Dairy Sector, Paper presented to 23rd Conference of Economists, Gold Coast, Qucensland.

Fane, G., and T Condon (1996), 'Trade Reform m Indonesia, 1987-19?S, Bulletin of Indonesun Econornzc Stitdm 32 (3) (this issue)

GATT (1991), 'Trade Policy Ilev~ew in Indonesia'. ?ol. 1, GATT Secretariat, Geneva.

GKSI (Gabungan Koperasi Susu Indonesia) (1991 and 1994), Profil GKSI, Jakarta (mirnco).

Hertel, T.W. (1??0), 'Gcncral Equilibrium Analysls of US Agriculture: What Does It Contribute? Jorirnal rrfA,qrzcultural Economics Rmarch 42 (3)

Houck, J.P (1986). El?mmts of Apcul tr iral Trade Polzmr, Macmillan, New York Irawan, B , and I W. Rusastra (1990). 'Economic Effncncy and Pratection Rates

of Milk Production in Central Java', in F. Kasrynn and P. Simatupang (eds), Comparative Adr'antage and Protrctmn Structiires of the Livestock and Feedstuff Subsectors in Indonesin, Center for Agro Economic Research, Bogor

Jones C. (1995). 'Rice Price Stabilisation m Indonesia. An Economic Assessment of the Changes in Risk Bearmg', Bulletin of Indonesian tconomic Studies 31 (I), pp. 109-28.

Just, R.E., D.L. Hueth and A. Schmitz (1982), Applled Welfare Economics and Public Policy, Prentice Hall, Englewood Cliffs NJ.

Kreinin, M E . (1983), lnteriintionnl Econonncs A Policy Approach, 4th ed., Harcourt Brace Jovanovich, New York.

Remenyi, J V (1986). 'Issues in Smallholder Tropical Dairying', Bulletin of Indonesinti Econoniic Studies 22 (l), pp. 57-87.

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The Social Welfare lmmct of Indonesian Dairv Palicie a3

Septiani, R A. (1988), Analisa Biaya Sumberdaya Domestik (BSD) Usaha Menghasilkan Bahan Baku Susu Bubuk Dalam Negcri, Unpublished Sajana thesis, lnstihlt Pertantan, Bogor.

Smith, D., B. Hutabarat, Y. Yusdp, B Saraya, P. Riethrnuler and J. Chai (1995). The Effect of Government Poliaes on Smallholder Livelihood An Indonesian Study. Paper presented to the 24th Conference of Economists, Unwersity of Adelaide

Tolley, G.S., V Thornas and C M. Wong (1983), Agncidtwn! Price Poitcies and the Deiw!optnf Countries, John Hopkins Unwernty Press, Baltimore.

Trewin, R., and T. Tornich (1994). Grains in Indonesia, Paper presented to a workshop on 'Gram in Asia. Reform and Internationalisatinn', Australian National University, Canberra, February.

Tyers, R., and K. Anderson (1992), Disarray in World Fmd Markets, Cambridge University Press, Cambridge

APPENDIX A THE FRESH MILK PRICE DETERMINATION PROCESS

A useful framework for consideration of the fresh milk price determination process is that of a bilateral monopoly. IPS can be considered a monopsonist in the fresh milk market since, as the association representing processors, i t is a dominant buyer. As a monopsonist it will attempt to maximise its profits by under-demanding and under-pricing its fresh milk input to the detriment of its suppliers, the milk producers The establishment of GKSI, as a single cooperative supplier of fresh milk or a monopolist, is a natural attempt to counteract the behaviour of the monopsonist IPS. As a monopolist, GKSI will attempt to maximise its profits by under-supplying and over-pricing its product. Thus, there will be an upper and lower bound of prices corresponding to the monopolist's and the monopsonist's profit maximising positions. The price outcome depends upon the relative bargaining strengths of the two participants. Theoretically, it can approximate the price outcome that would be achieved under perfect competition. This will be the situation if the participants are vertically integrated into related markets and maximise their joint profits

The above discussion points to the importance of market structure in considering the impact of policy instruments on the market However, once a pricing position has been reached, and if the underlying determinants of market power do not change, then prices will move more in line with fundamentals such as increases in costs.

What might be the role of government in all of this, given it has sanctioned the formation of the IPS and the GKSI? One role is to give the

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GKSI some influence as a monopoly supplier This could be done by banning imports, but the relevant policy instrument in the case of Indonesia is the import ratio that ties total supplies to domestic supplies. The value of the import ratio per sc will not affect this monopoly power. A high value of the import ratio will have the same effect on monopoly power as a low value so long as overall supply matches market demand at the respective market prices. However, if a low value of the import ratio is likely to result in over-supply then the monopoly power of the GKSI will be diminished.

The government may also wish to play a role in reducing the monopolistic position of IPS in the dairy products market, to prevent consumers from losing out to the joint interests of the 11’s and the GKSI. It can do this by allowing supplies of imported dairy products under tariff. This wi l l set a limit on what IPS can charge in this market, and hence what will be paid in the fresh milk market. The government could limit IPSs market power in other ways, and may wish to do so if the counteracting policy instrument of the import ratio is removed, for example hy abolishing import licensing and restrictions on investment.

The government could also introduce new counteracting policies that enable GKSI to control total supplies without the import ratio This could be done by means of high tariffs on milk inputs or by taking product off the domestic market via stock holdings or suhsidised exports, as the EU does. However, the7e latter arrangements are open to abuse (Bnhman rt nl forthcoming). For the long-term future of the industry, a id on consumer equity ground5, it would be better to open up the products market on removal of the import ratio, rather than to try to close up the fresh milk market by other means.

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the social welfare impact of indonesian dairy policies

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