Contract farming in Indonesia: Smallholders and agribusiness working together

Smallholders tend to lack the access to capital, marketing information and institutional support that producers with larger landholdings enjoy, and as a result, face a number of barriers to their development. One possible mechanism for improving the livelihood of rural smallholders and providing them with the benefits of economic liberalisation is contract farming. Contract farming is an intermediate production and marketing system that spreads the production and marketing risks between agribusiness and smallholders, reduces transaction costs overcomes market imperfections. Through contractual arrangements, agro-industry can assist smallholders to shift from subsistence or traditional agriculture to the production of diversified, export-oriented, higher-value products. This not only has the potential to increase the incomes of contracted smallholders but can also have multiplier effects for the wider rural economy.

Positive evaluations of contract farming generally indicate smallholders either benefit from contracts in terms of enhanced profits or leave them. Not only are there benefits in terms of improved access to markets, credit and technology, but contract participation can also provide improvements in risk management (as there are assurances their product will be purchased at harvest); increased family employment opportunities; and greater cooperation with government and agribusiness, which may lead to future beneficial partnerships and programmes. Also, indirectly, these contractual arrangements can lead to the empowerment of women and development of a successful commercial culture.

However, contract farming is not without its criticism, particularly as contractors tend to favour larger growers and hence poorer growers may be left out of the development process. There is also the potential for ‘capture’ of smallholders within contracts; the narrowing of local markets as contracted production squeezes out local food production; and deteriorating contract terms for smallholders.

This report presents the results of one Australian Centre for International Agricultural Research (ACIAR) sub-project in Lombok and Bali, Indonesia, which sought to identify opportunities for smallholder farmers to participate in contract farming, based on household surveys, and to determine policies to facilitate farmer entry into beneficial contractual relationships. The study concludes that there are a range of contractual types that can be mutually beneficial to both smallholders and agribusiness in Indonesia, and that more research in contracting is urgently needed. The commodity to be produced, the infrastructure and institutions available, and the capability of the smallholders influence the characteristics of a partnership arrangement. When developing contracts the following elements need to be included:

  1. Develop appropriate contractor groups (e.g. groups for seed rice, spatially diverse individuals for broiler chickens).
  2. Provide credit, inputs and technical and management advice in order to maximise productivity.
  3. Ensure smallholders repay loans to secure accountability and sustainability.
  4. Spread risk (price and yield) between smallholder and firm.
  5. Develop and implement quick and transparent payment systems.
  6. Allow contractors and contractees to come and go from the contract and allow the contract to evolve over time as capability, institutions and infrastructure develop.

Given the benefits of contracting in terms of greater returns to capital and increased demand for labour, policy makers in Indonesia should view these contractual relationships in a positive light and seek mechanisms to expand these types of interactions between multinational corporations and smallholders.

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