I. Theoretical Principles

Economics distinguishes between two types of profit. The first is normal profit, defined as the opportunity cost of a business, the minimum amount necessary to attract a business to an activity, and to induce the business to remain in it. Normal profit is defined in this report as the level of profit which yields a 25 percent return on the total amount invested by timber concessionaires to extract wood from the forest. Any profit over that amount is defined as excess profit, or economic rent.

According to economics, 100 percent of economic rent may be captured by a government through taxation without having a deleterious effect on the competitiveness of the companies paying taxes. But in Indonesia, the government has typically captured only a small portion of the economic rent in the timber sector through timber fees and corporate taxes. The remainder of the economic rent in the sector has been pocketed by integrated timber concession-plywood companies, or transferred by them, usually in an under-the-table fashion, to their political patrons.

Economics holds that firms have the ability to earn above-normal profit, or rent, in the event that either of two conditions are met. First, rent can be presumed to exist in all situations of imperfect competition. Second, rent can be earned in conditions where there are barriers to entry. Both of these hold true for the Indonesian timber industry.

Conditions of imperfect competition exist in Indonesia's timber industry because it is a producers' oligopoly, combined, until recently, with a sellers' monopoly. The industry has a producers' oligopoly because five private firms control about thirty percent of the nation's timber supply. The industry also had - until about a year ago - a sellers' monopoly because the export and sale of plywood, the nation's most important forest product, was controlled by the coercive Indonesia plywood producer's association, called Apkindo.

Barriers to entry also characterize the industry. Any firm that wishes to harvest timber needs a license from the government. However, such licenses are exceptionally difficult to come by. Those seeking licenses are far more numerous than those who receive licenses. The need to buy machinery is also a barrier to entry. Oligopolistic conditions within the industry, as well as barriers to entry, continue to ensure that rent is generated from the harvest of tropical timber in Indonesia.

The timber industry has enjoyed particularly generous and sustained rent earnings. The ITFMP has researched this phenomenon for over half a decade. We estimate that the rent that can be earned by a timber company from exporting a cubic meter of tropical roundwood at current prices and export tariff levels is US$30. This finding is shown in the following table.

Table 1.1 Rents available from the sale of a cubic meter of Indonesian roundwood at current world prices (all figures in US$)

Assumed Export Tariff on Roundwood (%)	Cost to Producer of Extracting Roundwood	Government Share of Rent	Rents Uncaptured by the Government
30	24	50	26
20	23	46	30
10	22	42	35
0	21	38	40

Notes related to above table:

The above table assumes a world price of US$100 for a cubic meter of Indonesian timber. This price represents an average of the prices of red meranti (which sells for US$125/m3) and mixed hardwoods (which sell for US$75/m3).

The table produces a series of calculations based upon what was until recently the roundwood export levy of 30%, the current levy of 20%, the projected year-end levy of 10%, and no export taxes at all.

The numbers used for cost to producer include a profit rate of 25%, a discount rate of 25%, and an interest rate of 25%.

Government share of rent includes revenues not only from export tariffs, but also from corporate tax, forestry royalties and reforestation fees.

All figures in the table were calculated using the ITFMP's Forest Concession Model (Scotland and Whiteman 1997a).

While the rents that could in theory be earned from the sale of Indonesian roundwood are huge, it should be pointed out that in reality Indonesian log exports have been forbidden since 1985. Between 1985 and 1992, if timber companies wished to export forest products, they did so by primarily by selling rough sawn timber or plywood. Then, since 1992, the government rendered the export of rough sawn timber impossible through the erection of a more-than-100 percent sawn timber export tax. Throughout the 1990's, plywood has been the main export option available to the Indonesian timber industry, although moldings and pulp exports have taken on a growing importance over time.

However, before the onset of the monetary crisis, the economic rent that could be earned from the export of plywood did not all go to plywood manufacturers. Some was raked off by Apkindo, the Indonesia plywood producers association. The amount that did go to plywood manufacturers is shown at the bottom of the following table, while the amount that went to Apkindo is designated as "Association Fees" and "Marketing Fees."

Table 1.2 Rents available to plywood exporters before the krismon

Factory Costs Labor Salary Glue Energy Additional Materials Buildings Machines and Tools Overheads Association Fees Total

8,060 11,844 54,144 10,551 89,770 775 21,972 32,571 11,562 241,251

Office Costs General Costs Marketing Fees Overheads Total

7,144 42,981 282 50,407

Roundwood Costs	540,500
Total Costs	832,158
FOB Price of 1 m3 Plywood	989,937
Depreciation	51,888
Interest	46,706
Remaining Potential Resource Rent (Total Costs minus FOB Price) in Rp	59,185
Remaining Potential Resource Rent (Total Costs minus FOB Price) in USD	25.18
Remaining Potential Resource Rent per m3 of Roundwood (USD/m3)	12.59

Factory Costs and Office Costs are derived from Scotland and Whiteman 1997b, Table 6.3, page 24 (excluding figures for "Factory Costs - Operating and Maintenance" and "Office Costs - Other Costs," which Scotland acknowledges were probably baseless figures).

Roundwood Cost is derived from Scotland and Whiteman 1997b, Table 6.1, p. 23, using within group prices for two cubic meters of red meranti, the primary raw material input for Indonesian plywood. Figures for Central Kalimantan are excluded, as the authors point out that they are anomalous. A log to lumber conversion ratio of 2:1 is assumed.

Plywood Price is derived from Scotland and Whiteman 1997b, Table 3.2, p. 10, using export market prices, but excluding figures for Central Kalimantan.

Depreciation figure assumes a plywood factory with machines costing US$26.5 million, which produces 80,000 m3 of plywood/year, and depreciates over fifteen years.

Interest figure assumes that half of the cost of machines, US$13.25 million, is paid for through a dollar loan that charges 12% interest.

Exchange rate is assumed to be Rp2,350/US$1.

Scotland and Whiteman 1997e, Table 4.6, p. 24, found that uncaptured resource rent from a cubic meter of plywood was even higher, $22.75. The point is, much timber rent in Indonesia is uncaptured by the state.

The two foregoing tables show the extent to which Indonesia's forest products sector has been a substantial rent earner. As shown in Table 1.1, before 1985, if current prices and revenue rates are any guide, the export of raw logs earned exporters between US$26/m3 and US$40/m3.

Then for over a decade between 1985 and 1998 - while the log export ban was formally in place - timber rents in the Indonesian plywood sector were largely divided between Apkindo and plywood manufacturers. Table 1.2 shows that Apkindo captured at least US$15/m3 through association and marketing fees. Assuming these fees were collected between 1985 and 1998 on an annual average of 6 million cubic meters of plywood exports, Apkindo captured US$1.2 billion in rent from these fees alone.

Even after Apkindo's share of rent is taken into account, plywood manufacturers were still able to capture about US$12/m3 in rent, before corporate taxes, for every cubic meter of raw timber used for manufacturing that led to plywood exports.

What the Table 1.2 does not show is that Apkindo also captured substantial rents downstream from the manufacturing process itself, from its shipping and insurance monopoly on plywood, and, it is alleged, from paying less to its members than the prices it charged to foreign buyers, and pocketing the difference (Pura 1995a, 1996). For a more detailed treatment of Apkindo practices, see the discussion on Bob Hasan in Section III.

Because it helps to explain the way in which timber resources were distributed in Indonesia, attention will be paid to the manner in which rents from selected timber companies, and by the plywood monopoly itself, were used to meet the political outlays and personal financial objectives of Indonesia's former leader, President Suharto.

Political outlays are defined in this report as payments made by the former President in order to keep his supporters satisfied. They included helping to finance the campaign expenditures of the ruling Golkar party twice every decade, and funneling national economic resources to - and therefore assuring the political loyalty of - powerful people in Indonesian society. Many of these disbursements took place through the political and social expenditures of the former President's 97 yayasan or "charitable foundations" (Time 1999: 23) but far more took the form of rent havens which were given to mostly Indonesian-Chinese businessmen who in turn passed these benefits along to key political supporters of the former President. (This vast network is best described in Robison 1986).

However, what makes Indonesia particularly interesting - and what appears to set it apart from other nations - was the high degree to which former President Suharto was able to direct the flow of economic rent from most sectors in the economy (including timber) not only to political expenditures, but to himself and his family as well. Estimates vary as to how much the Suharto family was worth by the end of the New Order era. But the most recently published figure suggest that the former President, his children, and his relatives were able to amass US$15 billion (Time 1999: 16-29).

To summarize, two key concepts need to be kept in mind in attempting to understand the distribution of Indonesian timber resources and the policies governing their use during the New Order period, and possibly beyond. First, the production of raw and processed timber gives rise to a substantial amount of above-normal profits, or economic rent.

Second, government officials in Indonesia tend to view economic rent not primarily in terms of how it can contribute to the development of the country, but rather how it can be used to assure their political longevity, and/or augment their personal financial holdings. This in turn is due to the fact that Indonesia's economy is not now, and never really has been, a capitalist economy like those in the United States and United Kingdom. Rather, Indonesia more closely resembles a statist economy, where most major decisions with respect to the allocation of resources must be approved by senior officials.

The next chapter is a discussion of the methodology used in this study.