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Impacts of Under-valued Domestic Log Price

E. G. Togu Manurung, Ph.D.

March 4, 2009. Presented at Rabuan Meeting. Ministry of Forestry

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Outline

1. Introduction:

* The problem of under-valued log price

2. Economy contribution of forest sector

3. Log price trend

4. Factors caused an under-valued log price

5. Impacts of an under-valued log price

6. Recommended solutions

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Intro: the problem of under-valued domestic log price

• Low pulpwood price from HTI Selling price: Rp 220-230,000 per m3 Vs. pulpwood price in int’l market ?

=> Sell it to int’l market? (export)

• Under-valued of industrial round woodever since early 1980s: log export ban policy

* Who Gain? Who Lost ??? The impacts?

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• Gross Domestic Product:

Rp 14.1 tn or 4.3.0% (1993) – Rp 136.0 tn or 3.4% (2007)

• Foreign Exchange:

US$ 6.24 bn or 11.7% (1997) , US$ 6.45 bn or 5.7% (2007)

• Government Revenue:

Rp 0.12 tn or 1.0% (1980) –Rp 2.10 tn or 0.3% (2007)

Over the period 1980 to 2007:

Resources Royalty Provision (or PSDH; 30.6%)

Reforestation fund (or DR; 67.6%)

Other royalty charges, including Forest Utilization Business Permit Fees (or IIUPH; 1.8%)

Economy Contribution of Forest Sector:Declining

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Log price trend(Nominal Price in USD/M3)

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

Domestic log price (US$/m3)

World log price (US$/m3)

Source: Forest Products Yearbook, FAOSTAT. 2009 (for world log price). BPS (2001) & Dephut (2008) for domestic log price

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• Illegal logging

• Market distortions: (policy & market failures)Log export ban policyVertical integration between HPH &

wood processing industry (no market mechanism)

Monopsony/Oligopsony in log market

Transfer pricing in wood industry

+ NOT take into account: externalities !?!

Factors caused an under-valued log price

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Market distortion: policy failure Effects of total export ban, general concepts

Price

m sd

P1 B A

P2 Cm

s

0 Q3 Q2 Q1 d Quantity

Indonesian exports

• Producers of logs, who receive a lower price for a smaller quantity of logs, lose producer’s surplus equal to the area P2CAP1.

• The loss to producers is greater than the gain of consumers by the amount shown by the area of triangle ABC.

• Thus for the Indonesian economy as a whole, there is a net loss resulting from the ban.

• The world welfare decreases also, from the area triangle mAo to that of dCo

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Market distortion: Effects of Monopsony in log market

Source: Klemperer, 1997.

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Impacts of an undervalued log price:on quantities and prices of timber products and industries

• Provide the domestic wood processing industry with a cost advantage in cheaper raw materials. As a result, domestic production of plywood and sawnwood became more profitable, and the corresponding processing capacity expanded.

• However, a lower domestic log price gives wrong price signals, which may create the impression of abundant timber stocks, in turn leading to excess of processing capacity as mills pay artificially low input prices (over-capacity).

• In the long-run, this situation can lead to a timber shortage (which threats natural forest conservation) and severe troubles within the wood processing industry (closing-down, downsizing as well as indebtedness of forest products industry).

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• An incentive for log smuggling due to a huge different between international and domestic log prices

• With the log export ban policy, Indonesian total export revenues over the period 1985-1997, in real prices, decreased by 12% (or US$ 6 bn).

• These losses resulted from large decreased in log export revenues that were not compensated fully by the gains from plywood and sawnwood exports (This finding is in agreement with Fitzgerald, 1986; Sidabutar, 1988; Lindsay, 1989; Manurung, 1995.)

• Indonesian government has also forgone considerable rent, in the form of export taxes, from timber exports.

Impacts of an undervalued log price:on exports and smuggling activities

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• With the log export ban policy, the number of direct jobs was higher by about 4876 in the plywood industry and 1045 in the sawnwood industry. However, for the same period, there were about 11791 jobs lost in the logging industry due to the reduction in production of logs.

• A changing composition of the work force has also occurred in forest industries. Previously, the logging industry was entirely composed of men who typically are the wage earners in Indonesian society, but after the expansion of the plywood industry more than 50% of the workers were unskilled young women, who were paid abut 30% less than men

Impacts of an undervalued log price:on employment

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• A lower domestic log price make the stumpage value reduced by 33%. The reduction of stumpage value resulted from selling logs at lower domestic prices, and also from the lower quantity of harvests. This has been an inducement to build excessive new capacity and to waste raw material.

• In addition, lower stumpage value would increase opportunity costs of natural forest management, and make forest conversion to other alternative land use become more financially attractive

• A disincentive for a development of industrial plantation

Impacts of an undervalued log price:on stumpage value

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• Lower stumpage value would decrease the government revenue.

• Moreover, it is a disincentive for more intensive forest management.

• It would lead to a high grading activity.

• The stumpage value is an economic rent, which should all be captured by government as a revenue source that stems from the country’s advantageous natural resource assets.

Impacts of an undervalued log price:on stumpage value

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Impacts of an undervalued log price:on wood waste produced

• Wood waste in logging operations

exploitation factor: 70%

• Waste in processing mills

Yield factor (rendemen) < 50%

(for sawmills and plymills)

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Recommended solutions

* Solve illegal logging:

• Solve land tenurial right problems,

• Solve over capacity problems,

• Solve low domestic log price problems

* Allow export log

* Expand timber products demand

• Provide technical assistance for SME industry

• Provide market access for SME industry

• Provide financial assistance for SME industry,

• Create and or support health bussiness environment

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Recommended solutions (cont’d)

• Get the market right (get the price right)

• Get the Institution right

Rules of the game: law and regulations

• Get the law enforcement right