Oil Palm Boom, Contract Farming, and Rural Economic Development: Village-Level Evidence from Indonesia

Abstract

Contracts between companies and local communities have been used in Indonesia for over 20 years to involve smallholder farmers in the emerging palm oil industry. Impacts of these contracts have not been analyzed systematically. Here, data from a village survey, spanning a time period from 1992 to 2012, are used to evaluate effects on rural economic development. Panel regression models with village fixed effects show that contracts have significantly contributed to wealth accumulation. Contracts signed before 1999 were more beneficial than contracts signed afterward, which is due to more public sector support and infrastructure investments during the earlier period. Contracts have contributed to decreasing inter-village inequality, not only because poorer villages were more likely to adopt a contract, but also because they benefited more from contract adoption than richer ones. The results suggest that well-designed contracts can be important for smallholder farmers to benefit from the oil palm boom. The village-level approach has clear advantages to evaluate direct and indirect economic effects, but it also has drawbacks in terms of analyzing environmental effects and issues of intra-village inequality. More research with various approaches is needed to better understand the multifaceted implications of oil palm contracts for sustainable rural development.