# 6. Conclusions and Recommendations

Fertilizer subsidies account for a large share of the support that the GoI provides to the agriculture sector, and in 2008 they were almost double the entire budget for the Ministry of Agriculture. Although there are circumstances under which subsidies can lead to efficient outcomes, by addressing market constraints, we argue that this is not the case in Indonesia. In addition, in light of limited fiscal resources, there is a trade-off between providing subsidies for private inputs and the provision of public goods and services. As such, the Government of Indonesia is spending large amounts on fertilizer subsidies at the expense of providing support in other areas that may matter more to farmers and the agriculture sector in general (extension services, R&D, irrigation).

The findings from the two rural household surveys in 2003 and 2007 show there was no targeting of benefits for the fertilizer subsidy program. Thus, most rice producers benefit from subsidized fertilizer regardless of whether they had small/large paddies or their level of wealth. The effect of this policy is regressive and the 40 percent largest farmers capture up to 60 percent of the total subsidy. Fertilizer shortages also mean that very few farmers (less than 10 percent in 2007) pay the maximum price as stipulated by the Ministry of Agriculture.

The subsidies contribute to an increased use of urea, which in some cases has resulted in an overuse that has a negative impact on yields. Thus, overall the relationship between fertilizer use and rice yields is best described as an inverted U-relationship, supporting the existence of an optimum level of fertilizer use, beyond which additional consumption has an adverse effect on output. The maximum level of urea use, at which the relationship with yields reverses from positive to negative, is in line to that recommended by the MoA. However, most farmers report that they use higher than recommended levels of fertilizer. Finally, the findings of this paper suggest that the costs associated with the fertilizer subsidy program, both fiscal and economic, outweigh the benefits from achieving higher rice yields.

Given the problems with the fertilizer subsidy system discussed in previous sections, the agriculture sector would be better served if a considerable amount of resources are reallocated. The GoI could improve the provision of public services for agriculture by investing in other agriculture public goods, which yield higher returns,<sup>19</sup> while keeping two specific objectives in mind: increasing the productivity of the agriculture sector, and increasing the welfare of farmers. There is an array of options for using newly freed resources, as fertilizer is just one of many determinants of yields and agriculture productivity that complement, but do not substitute, investments in: irrigation, extension services, improved agriculture marketing (particularly in the outer islands off-Java) and research and development in agriculture.

There may be a rationale for subsidizing the purchase of agriculture inputs by small farmers who may be credit-constrained, in light of the MoA’s goal to improve farmers’ welfare. However, fertilizer subsidies are only one of many options to do so and they may not be the most cost-effective instrument. A more cost-effective alternative to support small farmers and overcome potential credit-market constraints would be to establish a system of cash transfers, an area in which Indonesia already has extensive experience. With a well-targeted system of cash transfers for agriculture, farmers would be in a better position to determine the level and combination of inputs best suited to their needs. Fertilizer would be

> 19 Spending on public goods is likely to have higher returns than private goods, as discussed in the policy note Agriculture Public Spending and Growth, Indonesia Public Expenditure Review, World Bank.

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