Oil palm cultivation, household welfare, and exposure to economic risk in the Indonesian small farm sector

Abstract

The massive expansion of oil palm in tropical regions has substantial implications for socioeconomic development. Several studies show that smallholder farmers benefit economically from cultivating oil palm. However, most existing studies examine short-term impacts with cross-sectional data, which has two disadvantages. First, issues of endogeneity are difficult to address with cross-sectional data. Second, dynamic and risk effects cannot be analysed. We address both issues by using three waves of panel data from smallholder farmers in Indonesia and pseudo fixed effects panel estimators. We show that oil palm cultivation increases household living standards, measured in terms of annual consumption expenditures, by 13% on average. Moreover, we demonstrate that oil palm cultivation tends to reduce households' economic risk, measured in terms of potential decreases in living standard due to income variability. The risk-reduction effect is evident despite fluctuating international palm oil prices and consequences for oil palm revenues and profits. Oil palm requires less labour than alternative crops, thus freeing family labour for other economic activities. We find that oil palm farmers are more involved in off-farm activities, which helps to smooth income and consumption. Policy support may be required to address oil palm adoption constraints that some smallholders face. In addition, fostering the non-farm economy and improving household access to lucrative off-farm jobs are important for equitable rural development.