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8. Equity Effects of Rice Strategies

Rosamund Naylor

A more even distribution of income across groups of people and among regions of the country has long been a primary economic objective of the New Order government (Chapter 2). The importance of equity considerations in the selection of agricultural policies recently was highlighted in the Fifth Development Plan (REPELITA V) and in President Soeharto's budget speech of January iggo. This chapter provides an analysis of the equity implications of a trend self-sufficiency strategy for rice. At issue is whether the proposed package of incentive policies to promote increased rice production (discussed in Chapter 7) is likely to result in significant hardships for consumers of rice, thereby creating a trade-off between the government's food security and equity objectives.

The recent surge in rural incomes associated with successful economic growth policies has raised the income and employment levels of many of Indonesia's poorest people. But if future promotion of rice production will require increases in rice prices, some of the past improvements in equity may be offset. Because rice plays an important role in the expenditure patterns of poor and middle-income consumers, rice price increases will have a noticeable effect on the purchasing power of these groups. Following a strategy of rice self-sufficiency on trend thus may cause undesirable effects on personal income distribution.

Regional as well as personal distributions of income are relevant to policymakers. In this chapter, therefore, the analysis of income transfers associated with rice price increases considers rural and urban areas within five key provinces-East, Central, and West Java, South Sulawesi, and West Sumatra. Urban consumers are clear losers from price increases, but the effects on rural areas are less clear. As consumers, the rural popula-tion would prefer lower rice prices, but the negative impact of higher prices on rural rice consumers may be offset by the simultaneous effects of rice price increases on returns to labor and land.

Rice production is the largest employer of unskilled labor in the rural economy. Through their impact on the demand for labor, rice policies directly influence both the number of jobs and the wage rates offered to unskilled workers. Furthermore, effects on the labor market extend beyond those associated with direct employment of laborers in the paddy

fields or rice mills. The substantial increases in incomes from rice during the past decade, realized as profits or higher returns to land, have allowed concomitant increases in expenditures by rice producers. Many of these expenditures-for construction, services, and locally produced commodities-augment the total demand for unskilled labor. Because these expenditure effects have been prominent in recent years, many observers of Indonesian agriculture characterize the rice sector as the "engine of growth" in the rural economy.

Linkages between Government Policies, Rice Production, and Rural Incomes

The equity effects of policies can be represented as a series of induced income flows to consumers, producers, and factors of production, illustrated in Figure 8.1. One category of equity effects is represented by the direct income transfers that result from rice price, crop regulation, and irrigation investment policies-the principal instruments available to policymakers in the design of a new rice strategy (Chapter 7). Solid lines indicate the direct income transfers from policies. Rice price policy affects the cost of living for consumers by altering the share of the budget that they spend on rice. In the event of a price increase, consumers usually will reduce the impact of the price change by substituting in favor of other staples in the food budget. But the consumer is still worse off than before the price increase. In contrast, price increases raise the incomes of rice producers because revenue increases translate into higher profits or returns to land. Producers also gain income from the changes in regulatory and investment policy considered here. A relaxation of cropping restrictions allows farmers to plant more profitable crops; in most areas, that decision favors increased production of rice. Investment policy increases incomes by allowing more intensive cropping of a given land area; that change usually augments the production of rice.

Another part of the equity effects of rice policies can be analyzed through an examination of wage and employment levels for unskilled labor. The economic welfare of hired laborers rises or falls with corresponding movements in the wage rate and aggregate demand for unskilled labor. The review of the literature and the fieldwork on the structure of the labor market (described in Chapter 5) provide evidence that the market for labor on Java is gradually becoming integrated. Because the costs of migration-between urban and rural areas and among rural areas-remain high, however, local demand and supply conditions have an important influence on wages. Wage rates, even for identical tasks, are not the same across regions Relatively populated regions, such as Central Java, have lower wage levels than the less heavily populated regions (Chapter 5).

The overwhelming impression, nonetheless, is one of an active and well-informed market for unskilled labor. Migration is widespread among rice laborers; nonrice employment for some part of the year is essential to generate an adequate annual income. Research on temporary and circular migration patterns confirms that mobility for rural households has increased dramatically since the mid-1970s because of the development of transportation and communication networks (Hugo ig8i; Forbes 1981; Manning 1986; Sjahrir 199o). Workers now move easily to sectors and regions of the economy that offer employment opportunities.

Employment strategies-urban migration, migration to other agricultural areas, and working in local towns-differ among workers. Most workers are well aware of alternative wage rates, even in relatively isolated regions, and are ready to move to alternative employments if wage differentials become large enough. Wage rates vary among employments, but this wage structure usually can be explained by differences in the duration and difficulty of the job. Wages in each employment thus can be considered competitive with the alternatives.

Dotted lines in Figure 8.1 highlight the relationships relevant to the

demand for unskilled labor. All of the policies considered in Figure 8.1 affect the market for labor-either directly, through the demand for labor needed to produce rice, or indirectly, through the impact on the level of nonrice expenditures by consumers and producers of rice.

A significant linkage ties price policy to the labor market. Increases in rice prices raise the marginal value product of labor used in rice production. Initially, the value of these productivity increases will benefit producers in the form of higher profits. But if labor markets are competitive, increases in profitability will be passed on to workers through increased employment, higher wages, or some combination of the two. Increases in rice prices encourage producers to use more labor by planting more area to rice and by more careful planting, tending, and harvesting of the existing area. When producers compete for the services of hired labor, wages will have to increase to induce the necessary workers away from their alternative employments. If rice is unimportant in the total demand for labor, wage increases will be trivial; the necessary labor could be found easily without offering wages that are very different from prevailing rates. But if rice plays a large role in the total employment of unskilled workers, the impact of rice price increases on wage levels becomes more important.

The linkages between crop regulatory and irrigation investment policies and the labor market depend on labor use in rice production relative to that needed for alternative crops. Irrigation investment augments total agricultural area by creating more opportunities for multiple cropping. Rice is expected to be the main beneficiary of this investment; because rice is the most labor-intensive primary food crop, the total demand for labor will be increased. A relaxation in regulatory policy also will increase the aggregate demand for labor because rice production is more labor-intensive than the crops (sugar and tobacco) that are now grown on the regulated area.

The indirect effects of rice policies on the labor market are more difficult to trace. A change in profits accruing to rice farmers adds to household income that is either spent on the consumption of food and nonfood items, saved, or invested. Similar income flows are generated by a change in wage income in the rice sector. These expenditures and investments contribute indirectly to the growth in employment opportunities for unskilled labor, as long as the goods and services demanded are produced domestically (Hazell and Roell 1983). The extent to which expenditures create employment opportunities in rural areas depends on the predominant expenditures (e.g., housing, services, or education) and on the locations of production for the goods and services demanded (e.g., rural or urban).

The relevance of expenditure effects for rural wage rates and employment is also contingent upon the policies that initiate the flow of incomes between the product and factor markets. Public investments in technology, such as high-yielding seed varieties, and investments in irrigation and marketing infrastructure generally have positive impacts on rural incomes and employment. But these gains can be offset if the investment funds are raised through taxes on producers or consumers in rural areas. Rice price policy also has an ambiguous indirect effect because the expenditure of increased profits from rice production will be offset at least partially by a decline in real incomes for net consumers of rice.

Income Transfers from Rice Policies

Real incomes from rice farming more than doubled during the past twenty years (Chapter 6). Rice price and investment policies-including irrigation expansion, subsidies on farm inputs, and a guaranteed floor price for output-have contributed to much higher farm incomes. The impact of these policies on income distribution, however, remains a moot issue. This section investigates the income effects of the three policies proposed to implement the strategy of rice self-sufficiency on trend.

Rice Price Policy

A 5 percent increase in the real price of rice would generate transfers of income from urban to rural areas and from consumers to producers within the rural economy. The magnitudes of these transfers are determined by the amount of rice produced and consumed by each income group and the responses of supply and demand to the rice price change. The income distribution of individuals in rural and urban areas by region, as reported in the 1984 SUSENAS survey, is shown in Table 8.1. t Two distributions are shown, one for consumers and the other for producers. The classification of consumers is the most comprehensive summary of the income distribution because the sample consists of all residents in each region. The income distribution statistics for rural producers refer to the subset of the population that own or lease land .2

1 The income distribution represents the proportion of the population in each expenditure class. The terms income distribution and distribution by expenditure class are used interchangeably in the text, assuming that the savings rate is roughly equivalent among income classes. The expenditure classification shown in Table 8.1 represents a distribution around the middle-income group (almost 6o percent of the total Indonesian population), with skewness toward the lower-income group (32 percent of the total population). Less than in percent of the total population falls in the high-income group.

2 The income distribution of producers was calculated from rice consumption data reported in the 1984 SUSENAS survey. Data on rice consumption in the SUSENAS survey are disaggregated into purchased and own-produced rice. The quantity of own-produced rice in each income class as a proportion of total own-produced rice (for all income classes combined) was used to infer the percentage of producers in each income group.

The distribution of the consumer population by income group varies between urban and rural areas. Within urban areas, about two-thirds of consumers are in the middle-expenditure category. About one-fourth of the average urban population is in the high-income category, although this proportion varies by province. In comparison, rural areas have a much higher incidence of relative poverty. Except for West Sumatra, at least one-fourth of the rural population in each province studied is in the low-income category. This proportion is as large as 6o percent (Central Java).

The income distribution of rice producers (who are assumed to live in rural areas only) is spread more evenly and across all income groups, with some bias toward the middle- and higher-expenditure categories. About three-fourths of producers are in the middle- and upper-income categories. In all provinces, except South Sulawesi, more than one-third of rice producers are in the highest expenditure group. Given this distribution, the direct income transfers from rice policies will favor relatively wealthy households more than poor households.

Table 8.2 shows the short-run income transfers by region resulting from a 5 percent increase in rice prices. These transfers reflect producers' surplus gains and consumers' income losses starting with a base period assumption of national rice self-sufficiency. The gains and losses are calculated from regional production and consumption data and aggregate

short-run price elasticities of supply and demand.3 Price elasticities of demand incorporate substitution and regional income effects. (Assumptions and detailed results for the analysis of income transfers are presented in Appendix 8.1. )

A 5 percent increase in the rice price would transfer income from urban to rural areas and from low- and middle-income groups to the high-income group within rural regions, as shown in part i of the table. The largest gains from the price increase accrue to the high-income class in

3 A 5 percent price increase for gabah is translated into a 3.6 percent increase in the retail price, by assuming a 65 percent milling ratio and a constant marketing margin. The results are highly sensitive to marketing assumptions; for further reference on rice marketing in Indonesia, see Mears (1981).

rural areas, a group that encompasses more than one-third of rice producers but only 4 percent of the rural population. Aggregate income losses would be greatest for the middle-income category in urban locations, reflecting its large population share. Although many rural producing regions would benefit from the price rise, the low-income group in Central Java and the middle-income groups in West Java and West Sumatra-both with relatively large populations-would suffer net losses. This result challenges the widely held presumption that income transfers from urban to rural areas necessarily have positive equity effects in a rural-based economy.

The implications of the rice price increase for per capita expenditure are summarized in the lower third of Table 8.2. These data show the regressive incidence of rice price policy on consumers. Even though members of the low-income cohort consume less rice than people in the medium- and high-income categories, the welfare losses are greatest for the poorest group. Relative to per capita income, consumers in the low-income group lose half again as much as middle-income consumers and about four times as much as high-income consumers. However, the absolute magnitudes of income losses are small. Losses are about i percent or less of low-income consumer expenditures, except for West Java (1.25 to 1.53 percent). For the medium- and high-income classes, losses are generally less than o.8 percent of expenditure.

Irrigation Investments

Investments in new irrigation systems or the rehabilitation of current irrigation systems would have a favorable impact on producers' incomes without penalizing consumers, unless the investment funds were raised through new taxes .4 The principal income transfers involve the distribution of income gains between regions and among income groups within regions. The regional distribution of benefits depends on the location of planned projects, giving policymakers the capability to target areas of future production, income, and employment growth.

Within regions receiving investment funds, the size of the income transfer is affected by the nature of the project (e.g., rehabilitation of existing systems or conversion to production systems with better water control). Investment funds spent on the rehabilitation of technical irrigation systems in high-productivity areas on Java would have markedly different distributional consequences relative to funds spent on new land development in poorer regions off Java.

4 It is assumed that the investment funds are raised through the taxation of rents unrelated to the rural sector of the economy. Investments in irrigation have opportunity costs regardless of the source of investment funds, however. The opportunity costs associated with public sector investments in infrastructure development warrant further investigation.

Estimates of additional income to producers resulting from irrigation expansion and rehabilitation under the proposed strategy are contained in Table 8.3. The calculations are based on profitability per hectare for each type of investment multiplied by the incremental cropping intensity and number of hectares targeted for improvement in REPELITA V (Table 7-4).

The development of new irrigated land and the completion of existing projects on new land would generate the greatest increase in profitabilities. Relatively large income gains for these categories result from the substantial planned expansion of irrigated land, which amounts to almost 3 percent of existing rice area. These investments would direct income to farmers currently without high-productivity land, both on and off Java. A much smaller share of the funds would accrue to farmers in swampland regions, many of whom are in the low-income group.

Planned expenditures on conventional rehabilitation and the conversion of rainfed to irrigated systems are equally divided between Java and off Java. These investments would benefit farmers in all income groups. More information on specific projects within the plan is needed before a detailed assessment of income transfers is possible. But the data contained in Tables 7.4 and 8.3 indicate that the transfers would not favor only higher-income farmers owning good-control sawah.

Sugar Policy

A gradual reduction in the mandatory number of hectares devoted to sugar production offers an immediate means to increase rice production and improve farmers' incomes. Given the location of land under the TRI

program, the proposed phaseout of sugar primarily would benefit farmers who own medium- and good-control sawah in East and Central Java. Table 8.4 shows the additional income in constant 1988 prices that could be earned by producers under a phaseout of the TRI program.

The largest share of the income gains in East Java would accrue to producers in the high-income group. Additional income in Central and West Java would be split more evenly between the middle- and high-income groups. Over three-quarters of the total increase would go to middle- and high-income producers. Income growth in Central Java associated with the proposed phaseout would help to offset losses for the low-income group arising from the increase in the rice price.

Total Transfers

The transfer effects of rice price, irrigation, and sugar policies, forming a strategy to maintain rice self-sufficiency on trend, primarily would benefit rice producers, a high-income group. The exact pattern of regional income distribution cannot be calculated without more information on the location of planned irrigation projects. But the aggregate change in income levels within the rice sector can be predicted. The income transfer effects of the policies for the 1989-93 planning period are summarized in Table 8.5. The largest net gains in income would result from irrigation

investments. Net income growth from the combined set of policies, Rp 421 billion, is equivalent to io percent of total income earned in rice farming on Java in 1987 (Chapter 6).

The additional income generated by the proposed strategy would be divided among the factors of production within the rice economy. Land-owners would be expected to gain from increased returns to land and management. Increases in land rental values would benefit primarily the higher-income, landowning individuals in rural areas. Although the population of producers is well represented in each of the three income categories (Table 8.1), the low-income category of farmers has smaller landholdings. Land rental is also more important among this group, at least in relative terms, and the benefits of higher returns to land go to owners rather than tenants (Manning and Wiradi 1984). Landless laborers and family labor also would gain if they receive higher wages associated with future growth in total demand for unskilled labor. Wage increases would benefit all income categories; the aggregate benefits would be proportional to total individual employment.

Rice and Employment

The magnitude of wage rate effects in the unskilled labor market depends on the importance of rice in the total demand for labor. Aggregate and microeconomic evidence shows that the rice sector is becoming relatively less important over time as a source of employment. Rice employment has remained almost constant since 1969. Technical change, especially the introduction of sickle harvesting, has allowed per hectare demands for labor to decline; these decreases have been offset by increases in cultivated area. In 1969, for example, an estimated 7 billion labor hours were required to produce i 1 million tons of rice, whereas in 1987 approximately the same labor input was able to grow 24.5 million tons of rice. The rest of the agricultural sector appears to have behaved similarly, although employment data are incomplete and not fully reliable. Aggregate employment statistics for Java show annual employment growth rates in agriculture of less than i percent, whereas total employment grew at about 2.5 percent per year (Naylor 1989, pp. 154-156).

But in spite of its diminished role, rice still accounts for a prominent part of total employment. Although exact estimates of the proportion of employment provided by rice are not available, manipulations of existing data can provide a rough idea of the magnitude. Aggregate statistics indicate that the agricultural sector provides as much as two-thirds of the

total employment of unskilled labor. 5 These statistics do not allocate agricultural labor among commodities. Commodity-specific statistics are available for the shares of rice in agricultural GDP (z8 percent) and in harvested area (about 40 percent); these proportions understate the importance of rice in agricultural employment because rice production is more labor-intensive than most crops. If rice were to account for as much as half of agricultural employment, the share of rice in total employment of unskilled labor would be about one-third.

Approaching the estimation problem from a more microeconomic perspective points to a lower proportion for the share of rice in total employment. The production budgets developed for rice provide estimates of labor inputs per hectare (Chapter 4); these figures can be combined with data on total cropped area to yield an estimate of the total labor use in rice production. If it is assumed that i5o days represent the average annual employment for an unskilled laborer, total labor demand can be converted into years of employment. This number is then compared with the size of the working population to generate the share of rice in total employment. This procedure yields an estimate of zz percent for the employment share of rice. The share varies among regions; it is relatively large for West Java (z7 percent) and relatively small for Central Java (16 percent) (Naylor 1989, pp. 16o-61). These results are consistent with the pattern of employment opportunities described in Chapter 5.

The prominence of rice in the labor market-between zo and 30 per-cent of unskilled employment-is likely to continue into the next decade, particularly if policymakers choose a strategy to promote rice self-sufficiency on trend. The set of policies described in the previous chapter could create almost 1 million additional jobs in rice production by the end of 1993.6 Table 8.6 shows the estimated gains in agricultural employment resulting from area responses to price policy, the shift of TRI sugar land into rice production, and increased cropping intensities and area extension from planned irrigation investment. The measures are overestimated because the growth in on-farm employment from price policy-116 full-time jobs for each additional thousand tons of gabah produced-would be

5 Recent statistics reported by BPS show that the agricultural sector had about 55 percent of total employment in 1986 (Naylor 1989, p. io). If it is assumed that 15 percent of the total labor force is skilled labor and that the entire agricultural labor force can be classified as unskilled, the share of agriculture in unskilled employment can be estimated at 65 percent.

6 These calculations are based on an assumption of no labor input substitution in rice production. Full employment in the rice sector is estimated at 18o days per year on Java, loo days per year off Java, and 15o days per year for Indonesia as a whole. The average workday in rice production is assumed to be 5 hours. Labor input coefficients used in the calculations are based on 1988 estimates of 1,46o labor hours per hectare on Java, 550 labor hours per hectare off Java, and 1,15o labor hours per hectare for Indonesia as a whole (field survey data).

offset partially by employment losses from the reduced area planted in substitute crops. Moreover, labor-saving technical changes, like those that took place during the past two decades, could offset some or all of these potential new jobs in rice production.

The largest increase in rice labor demand is expected to come from planned irrigation investments. These investments will bolster agricultural employment in the long run through increased cropping intensities and area expansion. In addition, unskilled labor will be required for the construction and rehabilitation of irrigation facilities. Because of the indivisible nature of irrigation projects, employment growth associated with irrigation investments would be concentrated in the locations of new or improved facilities. These locations are not specified precisely in REPELITA V (Varley 1989). But most of the growth in area is expected to come from the completion of existing projects and new land development. As reported in Chapter 7, irrigation extensification will apply increasingly to remote areas because many accessible areas already have been developed. This pattern of development would improve the welfare of landless laborers in remote regions, who are often in need of additional employment opportunities because relatively few off-farm activities exist nearby.

Net employment growth resulting from a phaseout of the national sugar program also would have a regional impact on demand for labor. Impacts of this policy change would be concentrated in East and Central Java. Of the 150,ooo hectares of sawah that could be added to rice production by the end of 1993 under a reform of the current policy, roughly two-thirds are in East Java and one-third are in Central Java. A very small proportion (less than 5 percent) is in West Java. Estimates of additional demand for labor in agriculture from the phaseout plan are shown in Table 8.7.

A phaseout of the sugar program would allow sawah that is currently planted in sugar for sixteen months to be planted with as many as three rice crops and one or more palawija crops. The on-farm employment opportunities for various cropping patterns of rice and palawija greatly

outweigh the labor requirements for a single sugar crop. Sugar processing uses labor between the months of May and December when the sugar is milled, but the employment provided by processing does not compensate for sugar's lower on-farm labor requirements.

The employment effects of the set of policies associated with trend self-sufficiency could create enough demand for labor so that total labor use in rice production will not fall during the next five years, even with substantial input substitution for labor. In the absence of any labor substitution, employment gains in rice farming would be equivalent to roughly 15 percent of current rice employment, between 3 and 5 percent of the total employment for unskilled labor. The prospects seem good that rice em-ployment can retain its recent labor share, thus maintaining the promi-nence of rice in the labor market.

Rice and the Wage Rate

Real wages rose during the first half of the ig8os throughout Java (Chapter 5). Although this growth coincided with rising productivity and increasing prices in the rice sector, increased demand for labor in non-agricultural activities in both rural and urban locations was crucial. The importance for the labor market of demand forces external to the rice sector is suggested by comparisons of changes in wages with changes in land rental rates. Except for land subject to demand for conversion into nonagricultural uses, changes in the sales prices and rental rates for land are influenced principally by changes in the profitability of rice production. Net returns to fixed factors in rice production (rice-farming income) rose by over so percent during the first half of the ig8os (Table 6.7).

Table 8.8 shows the ratios of land rental prices to wages in rice production. Such comparisons are imprecise because of lags in the response of factor prices to changes in the demand conditions for land and labor (Jatileksono 1989). But the general trends suggest that the ratios of land

rentals to wage rates rose slightly in West Java (by perhaps 2o percent) and fell substantially in Central and East Java (between 4o and 50 percent). This result is consistent with evidence on real wage trends presented in Chapter 5, which showed much stronger growth in real wages (and off-farm employment opportunities) in East and Central Java than in West Java. Although the absolute ratios of sawah rental prices to wages were much higher in Central and East Java than in West Java, the ratios have gradually converged in recent years. Hence the welfare of laborers within the rice sector improved in relation to that of landowners, at least in measurable factor returns.

Available data do not permit a precise specification of the role of the rice sector in influencing the wage rate for unskilled labor. But the importance of rice in total employment makes it difficult to conclude that recent growth rates in wages would have occurred without substantial increases in rice prices and productivities. Productivity growth from technical change and higher rice prices increases the ability of producers to pay for labor services and compete against alternative employment opportunities. Because the rice sector is large absolutely, changes in that sector's demand create potential outflows of labor from it or inflows to it that are relatively large as well. The consequent impact on aggregate labor productivity and market wage rates should be noticeable. The derivation of the transmission effect is summarized in Appendix 8.2.

Since estimates of labor demand elasticities are not available, it is possible to venture only very rough guesses about the prospective magnitude of the transmission effect. The proposed self-sufficiency strategy foresees a rice price increase of 5 percent in iggi. If it is assumed arbitrarily that

the labor demand elasticities in the rice and nonrice sectors are equal, the impact of that rice price hike on rural wage rates can be approximated by multiplying the percentage price rise by the ratio of the share of rice in total rural unskilled employment to the share of nonrice in that employment. For example, if rice has a 30 percent share of unskilled employment, the impact on the unskilled wage rate of a 5 percent rise in the rice price could be about z percent (0.3/0.7 times 5 percent). Alternatively, if the share of rice in total unskilled employment is 2o percent, the estimated transmission effect would be 1.25 percent (0.2/o.8 times 5 percent). These calculations illustrate that the transmission effect could be significant, perhaps as high as 1 or 2 percent of the wage rate. This linkage would provide a potentially important favorable offset to the negative impact of higher rice prices on low-income consumers who are unskilled laborers in either rural or urban areas.

Rice and Expenditure Effects

Past expenditures and investments of households benefiting from increased returns to land and labor have led to higher levels of demand for off-farm goods and services. That increased demand, in turn, has generated demands for unskilled labor in a variety of rural nonagricultural activities. These changes have contributed to the growth in total demand for unskilled labor in the economy and, therefore, are partially responsible for the increases in real wage rates since 1976. But the impacts of the policy initiatives under consideration here are less clear. Net rice consumers will be forced to reduce expenditures on commodities other than rice, whereas net producers will be able to increase nonrice expenditures. Whether this transfer of purchasing power will benefit unskilled laborers depends on the expenditure patterns of the initial gainers and losers from price policy.

Data on budget propensities by expenditure group and region, contained in the SUSENAS survey (1984), are presented in Table 8.9. Household expenditure patterns by income class vary considerably. The share of household income spent on basic needs (food, housing, and clothing) is largest for the low-income group and declines as income levels rise. A sizable proportion of the household budget in the high-income class is allocated to durable goods, such as furniture, vehicles, and jewelry, as well as to education, health, and domestic servants.

In rural areas, roughly two-thirds of household income is devoted to the consumption of food items, and the remaining one-third is spent on non-agricultural goods and services, principally housing and utilities. Rice is the main expenditure item within the food category, accounting for 20 to 26 percent of total expenditures by the low- and middle-income groups,

which together constitute 92 percent of the rural population. For these income groups, housing and utilities are the dominant nonfood expenditures, followed by clothing and miscellaneous goods and services (e.g., health, education, and transportation expenses). Expenditures on parties and ceremonies, such as weddings and religious festivals, constitute roughly io percent of nonagricultural spending for all income classes.

A similar expenditure pattern exists for urban households. Food expenditures account for a slightly smaller share of the household budget in urban areas than in rural areas, although the share is still between 4o and 70 percent. Rice is the principal food expenditure for the lower- and middle-income groups. Within the nonfood category, the proportion of household budgets spent on housing is larger for urban areas than for rural areas, whereas the opposite is true for expenditures on durable goods and ceremonies. Urban households spend a significant portion of their incomes on education, health, domestic servants, and transportation expenses.

In most developing countries, the income elasticity of demand by rural households for nonfood consumption items is positive and often exceeds unity (Mellor 1984; Monteverde 1987; Timmer et al. 1983). Examples of rural-based goods and services with high income elasticities of demand are housing, education, and transportation. Accordingly, an increase in income received by relatively wealthy Indonesian rice producers, as a result of changed rice and sugar policies, would raise the demand for these goods and services in rural areas.

Labor intensities in the production of goods and services in each

expenditure category underlie the potential employment effects of policy-induced income transfers. Within the nonfood category, the building industry offers the most widespread employment opportunities, particularly for men (Chapter 5). Investments and expenditures on housing provide jobs in construction and in the manufacturing of construction materials such as bricks, plywood, tiles, and cement. In many of the villages surveyed, both on and off Java, men find local jobs in the dry season within the construction sector and do not have to leave their village or region to work. In villages where profits from rice production are particularly important, men migrate to large urban centers less frequently than in earlier years because of an increase in local construction activity. An increment in housing demand resulting from rice policies, therefore, would stimulate labor demand.

The clothing and textile industries are labor-intensive and employ unskilled labor on a seasonal and full-time basis at wages comparable to those in the agricultural sector. But these industries are not expected to benefit much from the proposed rice strategy because of the low budget share of clothing, particularly for high-income households. Furthermore, short-run income losses for many poor households, resulting from price policy, would curtail the demand for low-cost services (e.g., petty trade) that are often provided by unskilled labor. An anticipated rise in spending on transportation and domestic servants by the high-income group, however, would create additional demand for local unskilled labor.

The demand for labor in the agricultural sector also would be affected by changing patterns of food demand. Consumer demand for staples such as rice that have relatively low income elasticities of demand would change less than that for products with high income elasticities of demand such as livestock, fruits, and vegetables. These labor-intensive commodities offer a range of employment opportunities in production and processing. The expected increase in incomes resulting from rice policies in the long run, therefore, would enhance labor demand in both agricultural and nonagricultural activities.

Expenditure patterns derived from budget propensities, however, do not necessarily reflect the marginal changes in the patterns of consumption as incomes rise. For example, field observations indicate that education is becoming increasingly important for rural society in Indonesia. Rising expenditures on education most likely will improve human capital in both rural and urban areas but may not provide many jobs for unskilled labor in the short run. In this case, the existing data lead to an overestimate of the indirect effects of rice policies on the wage rate and employment.

Although the pattern of income transfers from rice policies seems likely to lead to increased demand for labor, this assessment of indirect employment growth resulting from rice policies cannot be conclusive. Data are insufficient to indicate anything other than plausible directions of change in total demand. The results discussed here are similar to those of other studies; income transfers favoring those with relatively high incomes have the effect of increasing the demand for unskilled labor (Hazell and Roell 1983). But the magnitude of that effect for Indonesia remains unknown.

Conclusion

An emerging trade-off between the objectives of food security and efficient income growth is likely to be encountered in pursuing a strategy of rice self-sufficiency on trend (Chapter 7). But the analysis of linkages between that rice strategy and the unskilled labor market shows that any future trade-offs with income distributional objectives probably will not be large. Whereas the direct income transfers from rice policies would accrue primarily to relatively high-income households in the rural areas, the evidence considered in this chapter also provides plausible grounds for expecting significant offsets to the negative impact of higher rice prices on consumers.

Higher rice prices transfer income from urban to rural areas and reduce the purchasing power of net consumers of rice in all regions. But this reduction in purchasing power would be offset partially by the impetus given to demand for unskilled labor. Rice is the most significant employer of unskilled labor; even though its relative importance has diminished substantially as the economy has developed, rice production continues to play a key role in wage rate formation. Rice price policy thus should benefit unskilled labor-directly, through the transmission of rice price increases to wage rates, and indirectly, through the demands of rice producers for goods and services that require substantial amounts of unskilled labor in their production. Although the directions of these offsetting effects are clear, their magnitudes are not measurable with existing information.

The proposed changes in regulatory and investment policies, necessary for the attainment of rice self-sufficiency on trend, would help maintain the prominent role for rice in unskilled labor employment. Employment in rice production could increase as a result of the proposed strategy; in contrast, the number of jobs in rice farming and milling probably would fall without further production incentives. The magnitude of the changes in the wage rate from regulatory and investment policies cannot be estimated. In addition, further research on savings, investments, and expenditures of farm households is required before a definitive assessment can be made of the cumulative effects of rice policies on the rural labor market. But the positive effects of higher wages and more jobs can be expected to provide some offset to the negative effect of higher rice prices on consumption expenditures of the poor.

One of the principal influences on the future equity effects of any rice strategy will be the growth rate of the Indonesian economy. If national income growth rates remain high, real wages should continue to increase. Rising real wages, associated with strong demand for labor outside of the rice sector, would have two counteracting effects on equity in the rural areas. By increasing incomes for unskilled laborers, rising real wage rates would ameliorate adjustments to higher consumption costs of rice. But the growing labor costs also would be likely to trigger greater substitution of purchased inputs for labor, thus reducing labor absorption in rice agriculture. These changes would diminish the role of rice in total employment and weaken the transmission of rice price changes and rice-dependent expenditure effects. But because such changes would be triggered by rising wage rates, the equity impacts of rice policy would be easier to tolerate-for policymakers and consumers.

Appendix 8. i. Analysis of Income Transfers

This appendix contains the data, assumptions, and results of the analysis of income transfers between consumers and producers. Income transfers are calculated on the basis of the change in consumers' incomes (a) and the change in producers' surplus (b) for gross (not net) producers and consumers of rice as a result of a change in the rice price.

The first section of results contains the information on changes in consumers' income. The price elasticity of demand for rice is calculated with the income elasticity and the compensated demand elasticity using the Slutsky formula. A single compensated demand elasticity is used for all income groups. The Slutsky equation is:

The average per capita consumption of rice in the base period (1988) is assumed to be 143 kilograms per year. This estimate is consistent with the calculation of consumption equivalent production for 1988 using a population estimate of 176 million. The average consumption level is distributed by region and income group according to the 1984 SUSENAS survey.

The second section of results shows the change in producers' surplus by region. The elasticity of supply with respect to the real rice price is o.2 in the short run, and the initial production level for 1988 is 43.2 million tons (Table 7.6).

Net income transfers among consumers and producers are shown in the final table. Assumptions for initial (average 1988) paddy and rice prices are Rp 2io and RP 450 per kilogram, respectively. Constant 1988 prices are used throughout the analysis.

Appendix 8.2. The Transmission of Output Price Changes to the Wage Rate

A simple two-sector model demonstrates the importance of the employment share and the elasticity of demand for the transmission of output price changes to the wage rate. The two sectors are denoted with subscripts r (rice) and n (nonrice). When the total supply of labor is fixed, any labor that is attracted to the rice sector as a consequence of an increase in the price of rice must be given up by the nonrice sector:

dLr = - dLn

where L = total employment in the sector.

If the labor market operates under competitive conditions, the wage rate offered by employers is equal to the value of labor's marginal product. In this case, the increase in the price of rice would create an immediate equiproportional increase in the wage rate. If the labor market is integrated, however, this initial increase cannot be sustained. When wages in the rice sector are higher than wages in the nonrice sector, workers would migrate from the nonrice sector to the rice sector. This movement, which reduces wages in the rice sector and increases them in the nonrice sector, would continue until wages in the two sectors were equal once again.

The change in labor demand in each of the sectors can be measured as the product of three terms-the initial size of the labor force, the elasticity of demand for labor with respect to the wage rate, and the percentage change in the wage rate. Given the assumed price increase for rice, the rice sector would expand and the nonrice sector would contract.

To focus on the role of the rice price change, an alternative expression can be substituted for the change in the wage rate in the rice sector. The ultimate change in the wage rate in the rice sector can be expressed by manipulation of the marginal value product formula. Total differentiation shows the proportional change in the wage rate, dw/w, as a composite of changes in the price of rice and in the marginal physical product of labor:

Substituting equation (5) into equation (4) and ignoring the term dP dMPP (as second-order small) yields the following expression for the transmission of the rice price to the wage rate:

This expression shows that the larger rice employment is relative to nonrice employment, the larger the transmission of the price change is to the wage rate. The relative magnitudes of the elasticities of demand matter as well, unless they are equal. In the latter case, the elasticity term becomes equal to one, and the transmission of price depends entirely on the relative magnitude of rice employment.

Finally, the relative change in the marginal physical product of labor in rice production is relevant as well. This term reflects the independent influence on the wage rate of the demand elasticity for rice. If the marginal physical product does not decline rapidly in response to increased employment of labor in rice (if the production technology exhibits constant returns to scale, for example), the demand for labor will be relatively elastic. In this event, much labor can be absorbed from the nonrice sector without requiring a very substantial decline in the wage rate. Rapid declines in the marginal physical product, on the other hand, are associated with inelastic demand for labor from the rice sector, and only a small migration of labor from the nonrice sector is necessary to force the wage rate toward the level that prevailed before the rice price increase.


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