ECONOMIC BENEFITS OF CONTRACT FARMING FOR SMALLHOLDER PALM OIL PRODUCTION: STUDY CASE OF NORTH SUMATRA, INDONESIA.

The palm oil production has experienced rapid growth for recent decades and has the potential to generate significant economic and social development in rural areas of Indonesia. The majority of palm oil production (80%) is situated on Sumatra island. Converting smallholder agriculture into a dynamic sector helps to increase the efficiency of rural economy through demand growth in other sectors. Unfortunately, there are numerous problems and constraints that smallholders face while striving to maximize their potential of palm oil production, e.g. ownership, access to information, securing capital, decision on land-use system and markets risks. The independent smallholders cannot maintain long term economic development because they are not able to invest in such projects as technical innovation or infrastructure innovation. Therefore, supported smallholder production has an advantage. Contract farming between smallholders and private companies could be potentially a way of overcoming of these problems and may play a role in improving welfare and increasing of incomes of the smallholders. Study was carried out in North Sumatra province during two periods in 2012 and 2013. Data were collected through semi-structured interview with local administration and NGOs and group discussions with local palm oil smallholders. Main questions were focused on attitudes of the respondents toward potential benefits from contract farming and income diversification. Study reveals that markets in target area are often poorly serviced that hinder potential benefits from increasing market orientation. Furthermore, smallholder face high transaction costs that are connected to market access strategies. Nevertheless, they perceive contract farming as a suitable tool to achieve income diversification through lowering costs of production and promoting high value crops with better extension and raising returns by higher prices for the produce. Contract farming seems to be the promising solution providing palm oil smallholders the access to more stable and profitable business relationships. Entering into a contract clearly yields higher value and improves the farmers' welfare and supports economic development of rural areas in North Sumatra. [ABSTRACT FROM AUTHOR]