VII. RecommendationsIndonesia's forests should not be as difficult to manage as they have turned out to be. For one thing, the responsibility for their management lies clearly with the state: most of country's forests are located on government land (a point that many NGOs and adat law communities dispute, but which for the time being remains the case). For another thing, forests are no losing proposition: they are full of commercially valuable timber species which can be harvested at a low cost and sold for a high price, hence generating above normal levels of profit. In theory, then, it should be easy for the government to control the resource, and make sure that the rent earned from it is harnessed to maximize the nation's welfare. However, the main point of this report is that precisely because timber is such a easy-to-obtain and valuable commodity, control over it and access to it has come to be monopolized by the most powerful elements in the country. These actors see the forests as something from which they can unofficially capture rent for themselves, in order to maintain position and wealth. The recommendations that follow in this final section are an effort to allow for the enormous value embodied within the nation's timber resource – the rent - to be returned to the government in a transparent and regularized fashion, and hopefully from there, to the people. When reading this final section, two important points need to be kept in mind. First, since the recommendations all aim to capture rents at various stages in the regulatory and production process, they are fundamentally linked. If the recommendations are implemented only partially, then the entire package will fail. The second point to keep in mind is that the recommendations have already been agreed to by the Indonesian government in writing. All that remains to be done is for them to be implemented faithfully. Since the recommendations all pertain to rent extraction, it is easiest to quantify them in terms of costs of production, profits, levies, and fees of a single cubic meter of red meranti, the industry standard. We do this in table 7.1 on the following page. For purposes of comparison, the table shows both how rent is currently divided for a cubic meter of red meranti, and how it should be divided. Column 2 in the table shows how rent for a cubic meter of red meranti is divided right now, according to Indonesian law. We start with a cubic meter of red meranti priced by the government of Indonesia at US$80/m3 for the purposes of taxation. The table then shows that it costs a timber company US$17 to take that cubic meter out of the forest, plus making US$5 in normal profit, which adds up to US$22. The amount left after subtracting out cost of extraction plus normal profit is US$58/m3. This is the total economic rent. The government then proceeds to apply various forest levies, including the dana reboisasi (US$10/m3), the PSDH (which, it was recently announced, would be raised to US$8/m3, although this has not yet happened) and smaller fixed fees (US$2/m3), all of which add up to US$20. This leaves US$38 in rent after forest levies. Corporate tax is then applied. But first, the $5 in normal profit made by the company on the cost of removing the log from the forest must be added back because normal profit, as well as above-normal profit, is subject to taxation. Adding rent after forest levies with normal profit we end up with a total profit of US$43 for purposes of taxation. The corporate tax rate is 35 percent. 35 percent of US$43 is US$15. This amount is subtracted out. That leaves the total amount of uncaptured economic rent at US$23. That is the amount that has historically gone to politicians (like former President Suharto, and his supporters), Apkindo, Golkar campaigns, non-timber related investment by timber companies (like the Salim group's rescue of Bank Duta, Barito Pacific's investments in the Chandra Asri and Tripolyta petrochemical facilities, or Nusamba's purchase of Astra shares), Swiss and Austrian bank accounts, and the like. Table 7.1: Current and recommended division of rent for a cubic meter of red meranti
We turn now to how the system described above can be reconfigured so that all timber rent is made officially available to the government, or set aside by them to create incentives for timber companies to sustainably manage their concessions, with nothing left over for above-normal earnings by timber companies, as such earnings are all-too-frequently passed along in an unproductive fashion to political patrons. Column 3 in the above table shows ITFMP's recommendation for how the rent on a cubic meter of red meranti should be divided. The price of the wood, the cost of extraction plus normal profit, and the size of the total economic rent remain the same. The only thing to change is how the economic rent is divided. To start with, we recommend that the government collect US$35 through stumpage fees (up from US$20), US$16 in performance bonds (currently companies do not deposit performance bonds), and a final US$5 from auctions (no timber concession has ever been auctioned in Indonesia, but the government has stated its intention to auction 10 million hectares by the end of 2000). This leaves no rent at all. The government is now eligible to take out corporate taxes. While there is no above normal profit left under this scenario, normal profit made by the company on the cost of removing the log from the forest is added back in. Normal profit amounts to 25 percent of the US$17 it cost the company to remove the log from the forest, or US$5. Total profit for purposes of corporate taxation is US$5. The corporate tax rate is 35 percent. 35 percent of US$5 rounds up to US$2. The above avenues for the government to capture timber rent correspond to the four recommendations in this section. Capturing rents through auctions is discussed in recommendation 1. Getting prices right so that maximum rent can be captured is discussed in recommendation 2. Creating area-based stumpage fees so that rents can be captured in full is discussed in recommendation 3. Capturing remaining timber rent through performance bonds is discussed in recommendation 4. The reason these recommended reforms must be implemented as a package is that if any of them is omitted, uncaptured rents will continue to exist. As soon as uncaptured rents are available for politicians to chase after, making a fast buck will become their priority, rather than seeing that the nation's forests are sustainably managed. We turn now to the second point, namely, that the following recommended reforms have already been agreed to in full by the Indonesian government in writing, as a part of the IMF and World Bank Policy Review Support Loans (PRSL's) 1 & 2. Under the terms of these loans, the Department of Forestry agreed to make a series of reforms in exchange for a massive transfusion of cash from the IMF and World Bank to the national treasury. One can formulate many criticisms of these forestry reforms. For one thing, the reforms in some cases are not specific enough. This criticism is especially applicable to PRSL 1, which was unavoidably drawn up under tremendous time and institutional pressure. A second criticism, which in many ways follows from the first, is that the IMF and World Bank did not consult enough with donors and NGOs about the content of the reforms. A third criticism is that the IMF and the World Bank have not been vigorous enough in verifying compliance with the reforms. This final criticism is valid. Criticisms aside, the fact remains that the reforms themselves are exactly what the Indonesian forest industry needs. Observers should think twice before throwing stones at the Bank, at least where its forestry agenda in Indonesia is concerned. The recommendations in this final section overlap with many of the reforms contained in the PRSL 1 & 2. Since all the foregoing recommendations have been agreed to by the government – in the context of its discussions with the IMF and World Bank - they should not be overly onerous for the government to fulfill. 1. The long tradition of giving away timber concessions to politically-favored parties should be brought to an immediate end. Timber concessions, if their licenses are to be extended, or are being offered for the first time, should be auctioned. Concession size limits of 50,000 hectares should be abandoned, as concessions of less than 70,000 hectares are thought to be inefficient or unsustainable or both. The primary impediment to the formulation and enforcement of a properly conceived Indonesian timber policy has been the handing out of timber concessions, with the expectation that recipients will either pay political obeisance to the President, or worse, provide him with under-the-table funds. Political patronage is not a system that goes away easily, and it appears that the government is building a new system for the discretionary distribution of timber concessions. The new system respects existing timber licenses, but calls for concessionaires to give 20 percent of their shares to cooperatives at the time of license extension, for a million hectares timber concessions to be awarded to cooperatives, and has now resulted in East Kalimantan's governor awarding timber concessions of up to 20,000 hectares (Media Indonesia 1999). The problem with such a system is that it creates a new set of client concession holders who realize that the rent they will earn from their concession is a gift from a political patron, in this case, the governor of their province, and the political party to which s/he belongs. These small concession holders will in all likelihood be under some form of obligation to make unofficial, under-the-table payments to support the governor, at a minimum helping him buy votes for his party at election time. The unofficial appropriation of timber rent for political purposes prevents timber, a valuable national resource, from being used by the government for legitimate development expenditures, at precisely the moment when those expenditures are most needed. The alternative to the discretionary patron-client system of timber concession distribution is a more neutral, fair, transparent, and competitive system, namely, auctioning. Last year the Department of Forestry implemented a regulation allowing for the auction of new or expired concessions under the terms of the PRSL 1. What a properly functioning auction system would look like is described in detail in Fraser and DeKock 1998, and Muljadi and Fraser 1998, publications available free of charge from ITFMP. While the Department has acted to make auctions possible, and even posted the specifications for potential bidders, there are problems. First, the Department seems uncertain about which concessions it wants to auction, and has released widely varying numbers and locations of concessions to be auctioned. Second, although the concessions will be "auctioned", they will not necessarily be awarded to the highest bidder. Instead, the grounds on which concessions are awarded will be purely at the discretion of the Minister of Forestry. Third, the Department has said that HPHs can only be bid for by companies based in the province in which the HPH is located, meaning that Indonesian companies from outside the province cannot bid. In short, while the Department has stated its readiness to put 10 million hectares of concessions on the auction block in the near future, it has to some extent rendered the process of auctioning meaningless, by making it discretionary, non-transparent, and closed to parties even within the country. The Department's ostensible reason for offering a non-competitive auctioning system is that a competitive system would allow the same wealthy and politically-connected timber companies to dominate the industry. At least two facts suggest that this may not be the case. First, the Department has already enacted limits on the size of concession holdings of all timber groups to 400,000 hectares nationwide. Hence, the large and even the mid-size conglomerates will not be able to bid in auctions, unless they do so through shadow or shell companies, which the Department should be able to keep track of. Second, as shown in table 7.1, a properly conceived auction system will be one in which concessionaires only have to bid about an eleventh (5/56 to be exact) of the total post-corporate-tax economic rent generated by a given concession, US$5/m3 in the (admittedly idealized) case of a pure stand of red meranti. This is an amount that interested and legitimate timber companies should be willing and able to pay. While ITFMP supports the idea of limits on the overall holdings of timber groups to 400,000 hectares, limits of 50,000 hectares almost certainly will prevent capital intensive companies from operating at a profit. This is because our research shows that timber concessions require a minimum size of 70,000 hectares to turn a profit (Scotland 1998). Unfortunately, the first place where concessionaires cut costs are in areas related to silviculture, training, research and other aspects of their operation that encourage sustainability. Hence, we are pleased to see that the Department is now reconsidering its regulation to limit concession sizes (Jakarta Post 1999s). 2. All segments in the primary processing segment of the Indonesian timber industry deserve to be paid world prices for their products, not only the exporters of plywood. The easiest way to achieve this is to allow the free export of logs and rough sawn timber, which means lifting the requirement for multiple letters of permission prior to being able to export these commodities. The elimination of high export tariffs for roundwood and rough sawn timber is contained within the PRSL 1. As a result of that agreement, the government cut the 200 percent export taxes on logs and rough sawn timber to 20 percent, and has promised to lower the tax further to 10 percent by this year's end. The problem is, that although export tariffs have been - or will be – cut substantially, they have been replaced by a system requiring multiple letters to authorize roundwood and rough sawn timber exports. If the requirement for export letters were to be removed, this would allow Indonesian timber concessionaires to export raw logs and rough sawn timber. For the first time in more than a decade, Indonesian concessionaires would be paid the world prices for their logs, which is currently around US$110, rather than the prevailing Indonesian domestic price of US$50/m3. The spread that Indonesian sawmillers could earn on the export of rough sawn timber is even larger. If sawmillers were allowed to export, using here the example of rough sawn red meranti, they would be paid the world price of $770-850/m3 (Tropical Timbers 1999: 3), which is vastly higher than the Indonesian price (between US$45-55/m3 last September – the domestic price of rough sawn timber has almost certainly risen this year, although by what amount is unknown). In short, if non-tariff barriers on the export of logs and rough sawn timber were removed, exporters of these commodities would stand to earn far more. As the export price for raw logs and rough sawn timber rose, so eventually would the Indonesian domestic prices of these two products. A rise in domestic price would simultaneously produce welfare and redistributive effects. The welfare effect would be that Indonesian forest products exporters would be richer – since they would be paid world prices of $110/m3 for their logs, rather than Indonesian prices of US$50/m3, and world prices of US$770-850 for their rough sawn timber, rather than the domestic Indonesian price not too far above $45-55/m3. Removal of restrictions on the export of raw logs and sawn timber would also have a redistributive effect: plywood manufacturers would no longer be the primary captors of Indonesian forest rent. As things stand now, plywood companies buy roundwood – either from their own concessions, from other non-affiliated concessions, or from illegal loggers – at an artificially low domestic price, process that roundwood into plywood, and sell most of it on the world market at high international prices. However, if the price they paid for wood domestically were to rise, then the margins on which they could collect rent would shrink. The amount by which plywood exporters' rent shrinks will more or less correspond to the amount by which that of log and rough sawn timber exporters' would rise. While this paper argues that lifting export restrictions on Indonesian forest products is a good idea, there are possible consequences from this course of action which must be considered. There are many observers who believe that once Indonesian timber exporters of raw logs and rough sawn timber are given access to the world market, this will not succeed in pulling up the prices of those commodities on Indonesia's home market, because Indonesian illegal loggers will simply flood the country's domestic market with an even greater supply of low price black market logs stolen from the country's unprotected forests, and that therefore domestic log and rough sawn timber prices will stay low. The logical extension of this argument is that Indonesian black market logs will eventually spill out into the world market, and this will simply serve to drag down the world price of tropical timber, simultaneously impoverishing tropical timber exporting nations, and destroying Indonesia's forests even faster. There actually is no clear and definitive answer to the question of whether -- given the complicating factor of an unchecked market in Indonesian illegal logs -- a genuine freeing of raw log and rough sawn timber exports would be more likely to lower world prices, or raise domestic prices. One thing that does seem clear is that until the problem of Indonesian illegal logging is solved, many if not most of the recommendations made in the section will remain of secondary importance. 3. The Indonesian government should capture all timber rent, preferably through the use of a single area-based fee. Indonesia's stumpage fees are far too low as they stand. For example, rent now being captured by plywood manufacturers (and not being captured by the government) is at a pre-corporate tax level of US$86 for each cubic meter of roundwood consumed, as shown in Table 6.3. At a time when the country is in an economic crisis, and the government is having to borrow billions of dollars from multilateral banks simply to finance routine spending, the government has not taken advantage of the higher revenues that could be earned from taxing the timber industry at a level which captures full economic rent. The Department of Forestry should take advantage of the relative absence of timber-rent-hungry parties at the pinnacle of power, and raise timber taxes before another powerful leader emerges in Indonesia who regards the nation's timber resource as a personal campaign warchest and financial fiefdom. After taxes, concessionaires now pocket US$23 (plywood manufacturers, US$86 before corporate taxes) for each cubic meter of red meranti sold. As shown in table 7.1, the pre-corporate tax level of economic rent is US$56/m3 for red meranti. Capturing 60 percent of this amount, as the government has agreed to do, would mean that the new stumpage fee would be US$35. While the government agreed to adjust stumpage fees to capture 60 percent of economic rent by 31 March 1999, in reality the government has only stated its intention to raise the smaller of Indonesia's two main timber fees – the PSDH or forest products royalty – by US$3 per cubic meter of red meranti, which would mean that the overall stumpage fee for a cubic meter of red meranti will rise from US$17 to US$20. In short, the current system of stumpage fees in Indonesia falls far short of where the Department promised it would be. In addition, if the government wishes to denominate timber fees in dollars, but collect them in rupiah, as they now do with the nation's larger timber fee - the dana reboisasi or reforestation fee - they should collect fees based on the actual dollar-rupiah exchange rate, not the artificially low exchange rate of Rp5,000/US$1 which the government currently allows concessionaires to pay. In revising timber fees, it is important for the government to index fees to the world price of roundwood and rough sawn timber, not the artificially low domestic wood price now prevailing. For the purposes of our calculation, we have assumed a world price of US$80, a plausible future price for red meranti, as it averages the current Indonesian domestic price for red meranti of US$50/m3, and the current world price for the same wood of US$110. US$80 may be a good price on which to index forest fees, as it corresponds exactly with the price on which the government currently bases stumpage fees for red meranti. In order to optimize the efficiency of the country's forests, and in order to minimize illegal logging, stumpage fees should be based not on the volume of wood that is removed, but on the volume of wood that could be removed, which is to say, based on the area to be logged. A fee calculated only in terms of the cubic meters removed from a concession is referred to as volume based fees. The problem with a volume based fee is that it creates a set of perverse incentives for timber concessionaires. By levying taxes on the volume of wood removed from their concessions, the government creates an incentive for concessionaires to "high grade," that is to say, to remove only a few of the very highest quality trees in any given coupe, and a disincentive for concessionaires to remove lower quality but still usable logs, as well as lesser known species. As a result, lower-than-optimal volumes of roundwood are produced nationwide, and more virgin forest needs to be harvested in any given year, on average, than would the case if concessionaires were to use all the mature trees of commercial value contained within their coupes. Under an area-based fee, concessionaires pay royalties based on the standing stock of mature, commercially valuable species contained in the annual harvesting block. By charging concessionaires for the trees they could take, area based fees give concessionaires not only the incentive to harvest top quality trees (which they would do in any case), but also the incentive to harvest second quality trees, and lesser known species, all of which ought to be used. An area based fee should go a great distance toward cutting out the primary supply of wood for illegal loggers. Under the current system of volume based fees, concessionaires have only the incentive to harvest top quality trees. They leave behind second quality trees and lesser known species. Illegal loggers sneak into timber concessions and steal those second quality trees and lesser known species, typically in the same year that roads are opened into primary forests. Although no such system has been introduced to date, as a part of the PRSL 2 the government did agree to complete the analysis and draft design of an area based revenue collection system for concession operations by June 30. 4. To ensure that logging is carried out sustainably, concessionaires should post performance bonds with simple criteria for success or failure. The performance bond is the final necessary piece of the mix of policies recommended in this report. A performance bond is money that concessionaires are required to pay up front before they begin to log. If the concessionaire logs in a way that is non-sustainable, it will have to forfeit part or all of the bond. Non-sustainable practices include: stealing logs from adjacent protected areas or other timber concessions; harvesting trees outside of the approved annual cutting area; harvesting trees that are less than 60 cm diameter at breast height (dbh) in limited production forests, less than 50 cm dbh in production forests, or less than 40 cm dbh in swamp forests; making skid trails that are too wide, or too long. If companies harvest their concession sustainably, they get their performance bond back, with interest. As with all of the recommendations made up to this point, performance bonds are about making sure that the rent embodied in Indonesia's timber resource ends up with the government, where it will be hopefully dispensed in a policy-neutral and rational fashion, and which would in any case be preferable to having it hijacked by politicians and stolen by illegal loggers. To review, the after-corporate-tax level of timber rent for each cubic meter of red meranti is US$56. It is recommended that US$5 of that amount be captured through the auction of the concession. Another US$35 should be captured through area-based stumpage fees. This leaves US$16, the average amount at which it is recommended performance bonds be set. As a part of the PRSL 2, the government has agreed to establish a performance bonding system by 31 March 1999. No system has been introduced to date, but the Department appears to be more serious about performance bonds than any of the other reforms recommended in this paper. Performance bonds are a part of the reform bill sent to the DPR by the Department of Forestry in August, 1999. To conclude, Indonesia's forest is a treasure of almost inestimable value. The problem is, some politicians appear only to see the forest in terms of what it can do for them personally in the short run, to generate enormous amounts of informal rent. These leaders are addicted to rent, hence the title of this report. Although it is a time of great uncertainty in Indonesia, now is the best time for more responsible elements within the current government to move quickly and create a set of laws that prevents less responsible elements in current and future governments from gaining illicit access to forest rents. The best way to achieve this end is for the government to do what it has already said it will do - that is to say – to return the forest sector to normal market conditions which have been absent for so long, and to legally capture rent through a linked set of forest fees. To this end, this report recommends concessions no longer be discretionarily distributed by the government to politically favored parties, but auctioned to the highest bidder. The government should stop trying to depress the local price of timber, as this only results in powerful companies buying logs at cheap prices, turning those logs into plywood, which they sell for astronomical profits on the world market, with little benefit accruing to the people of Indonesia. Instead, this report recommends the government craft timber revenue policies that allow it to capture the enormous rent embodied in the nations' timber resources, so that these proceeds can then be used to help the nation. Timber revenues should be set on an area basis, so that valuable timber is removed, rather than left for illegal loggers to steal. Finally, the report recommends that timber concessionaires be required to post performance bonds, revocable in the event that they do not log responsibly.
September 7, 1999
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