May 3, 2006

New Institutional Approach to Forest Property Right

II.

New institutional approach (NIE) has been a path-breaking approach to the understanding of capitalism (Ankarloo, 2002). NIE has significant contribution because it attempts to make neo-classical economics more historical, realistic and social in its approach. That is why institutions become important to reflect an idea of well-functioning market economy will work if institutional framework is effective. In the NIE point of view, institution exists as a means of reducing transaction and information costs (Stein 1994:1835). The theory assumed that market is imperfect and information is asymmetric in the case that price information on particular product is received differently between the buyers and the sellers. Consequently NIE explains rationality arising out of asymmetric information is bounded depend on information that each parties have. It assumed that market is not working perfectly because of misallocation of resources. In that case, the role of institution is to provide structure for exchange, which reduces transaction and information costs (North 1990 as quoted by Stein 1994:1837). Property right represents agrarian institution, which determined how social, cultural, political and economic relation in agrarian society are conducted (Akram-Lodhi, 2005). In the context of forestry management in Indonesia, state property right represent the way in which it would reduce transaction cost. Considering that large forest area covered by MoF as well as diversity took place within archipelago, state property right is the best way to resolve the problem of property insecurity. In addition, at early 1970s in order to encourage investment especially in forestry, it is important for government had to secure of property right (McCharty 2000b). As soon as property right was settled down to implement exclusivity and transferability of forest, MoF had performed mechanism upon it such as mapping, mark forest boundary and forest allocation. It has been argued that well-functioning market is result from institutional effectiveness. State property right thus acts to make exchange possible especially between the state and investors. NIE would argue that when MoF mark forest boundary, map the forest and allocate them then transaction would be low (Ankarloo, 2002). Stein (1994: 1834) would also suggest that state plays a role as external guarantor to make forest transferable and exchangeable. Furthermore NIE believe that gains from trade would be obtained similar result from that of neoclassical argument. In that point the role of state is obvious in forest management in Indonesia. MoF has set rules and regulation regarding to forest exploitation. As it has been said before that concessionaire would get right to use forest over 35 years as well as the liability of concessionaire to minimize environmental impact during concession period. In addition, the basic forestry law stated that MoF would manage forest by allocating and giving concession right to any parties who are able to comply with concession contract. Considering that forest management is capital-intensive investment, not surprisingly only big companies involved in forest extraction. The famous timber tycoons are Prajogo Pangestu and Bob Hasan, the earlier has concession over 5.5 million ha of forest (McCarthy 2000a: 103) The implication of asymmetric information is moral hazard (Akram-Lodhi, 2005) lead to environmental degradation. Principal agent model (Romstad 2001:100) explained that agent (concessionaire) is more well informed rather than of principal (state). That is why although state impose forest levies in order to control unsustainable practices, concessionaires who have better information try to maximize their profit by choosing the cheapest method that they could. In 1998, forest fire delivered haze, which had cause widespread health problems as well as halt economic activity. Forest plantation companies are one of actors who contributed to the escalation of the fire (McCarthy 2000a: 112). For company it is cheaper to burn the land while preparing the land. Another case is high grading[3] where for profit motives, concessionaire take only valuable species and left others standing. This is because concessionaires know better the location of valuable species even in reality they steal it from other area such as protection forest. Concession arrangement become important for defining secure environment for company to operate as argued by NIE it can reduce transaction costs. Thus, the length of concession has to be taken into account, which gives capacity to concession holder to invest in the long-term. In Indonesia, within period of 35 years, concession holder works under their bounded rationality in knowing whether the concession would be extended or not. In addition, in 35-year concession period, company only have 1 round forest extraction which means companies do not have any incentive to replant even recover any environmental damage because of such uncertainty above. As a result, they turn uncertainty over concession period into maximizing timber production as already describe above.

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