My Say: Cutting the plantation Gordian knot

This article first appeared in Forum, The Edge Malaysia Weekly, on October 1, 2018 - October 07, 2018.
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Early last month, Primary Industries Minister Teresa Kok announced that the government will not allow any more expansion of oil palm plantations. In my view, this is one of the most significant economic policy decisions in recent history — an economy still dominated by plantation economics deciding to stop its expansion.

This decision is as disruptive as it gets but it is what is needed if there is to be a structural change in the economy. The challenge is how to implement such a decision when the economy seems to be facing some headwinds.

Fairly recent numbers on oil palm plantations speak very loudly. As at last year, almost 5.8 million hectares of land in Malaysia were planted with oil palm — that is more than having the whole of Pahang and Perak covered with oil palm, or the equivalent of over 40% of the land area in Peninsular Malaysia. Only 10 years before, in 2007, it was 4.3 million hectares; a 35% increase in a decade. To put things into perspective, in 1980, only one million hectares were planted with oil palm.

So, what started with rubber, driven by the colonial logic of availability of abundant land and cheap labour, was greatly expanded during the last three decades. The plantation sector is today a feature and creature of modern Malaysia. The logic may have been colonial in origin but its expansion is purely a Malaysian phenomenon.

Despite the passage of time and expansion of area under plantation, fresh fruit bunch (FFB) production per hectare — a measure of plantation productivity — remained largely unchanged. In fact, it declined slightly from 19 tonnes per hectare in 2007 to just under 18 tonnes per hectare last year. The palm trees are yielding about the same amount of fruit.

Clearly, this sector is not seeing a rise in productivity. Total output increased simply because more inputs were used — more land was converted into plantations. Another measure of productivity is the oil extraction rate (OER) — the percentage of crude palm oil extracted from the FFB in weight — a measure of the quality of the fruit in terms of its oil content. This has also remained static throughout the 10-year period — the overall OER hovered at around 20%. Therefore, neither the amount of fruit per hectare nor the quality of fruit produced has improved, despite a substantial increase in the area planted with oil palm. There has been little technological progress.

In nominal terms, the value of exports of palm oil products in 2007 was RM45.1 billion. This grew to RM67.6 billion last year. This increase in the nominal value of exports lagged behind the increase in nominal gross domestic product in the same period. Thus, from a relative value creation perspective, the real increase in export revenue is marginal despite the increase in land area. The share of palm oil-related exports declined as the overall economy grew faster than the sector itself.

So, why do we keep allocating increasing amounts of land — mostly deforested land — to an economic activity that has not shown much technical progress, therefore, one with stagnant productivity? Because it is a profitable business!

The market capitalisation of plantation companies — including rubber plantations — listed on Bursa Malaysia is just under RM150 billion, almost 8% of the total market capitalisation — still a significant sector. There are many other privately held plantation companies. The larger plantation companies on Bursa — with scale of operations and good management — obtained return on equity of about 10% and their shares are trading at a price-earnings ratio of about 20 times. These are profitable companies, which also attract investors who are willing to pay for their shares.

Formerly British plantation companies, such as Sime Darby, Guthrie and Golden Hope, were taken over by Malaysian interests in the 1980s. Bumiputera fund manager, Permodalan Nasional Bhd, owns the bulk of these interests via the restructured Sime Darby.

The Federal Land Development Authority, which was started on a plantation logic to enable land ownership, has also evolved into a major plantation concern. These entities and major public-listed plantation companies, such as IOI Plantation Services Sdn Bhd, Kuala Lumpur Kepong Bhd and Genting Plantations Bhd, have expanded their plantation holdings. Funds such as Tabung Haji and the Employees Provident Fund also own stakes in these plantation companies.

The profitability of oil palm plantations has not only resulted in the expansion of the area planted with oil palm but it has attracted institutional investors that depend on this profitability, and many of these institutions are forms of wealth-sharing mechanisms — distributing dividends to subscribers to the funds. So, plantations are embedded quite deeply into the Malaysian story.

 

That is the conundrum

Doing more of what is profitable at the firm level does not translate into an increase in national productivity, but the embeddedness of palm oil in the economy is the Gordian knot that has sustained its stranglehold on it. From a sustainability point of view, doing more entails creating a larger carbon footprint.

Two things resulted from this expansion of plantation hectarage. The first was that capital allocated to the sector hit diminishing returns as growth was driven primarily by inputs. Returns on capital have remained acceptable only because the labour input used in plantations shared a small percentage of total income derived — mostly low-paid migrant labour nowadays.

Though diminishing, the risk-weighted return on capital invested in plantations is much better than the returns on new, emerging sectors of the economy. This second effect is the stranglehold the plantation sector has had on the economy. It distorted the resource allocation in that not enough resources were allocated to “doing new things”. The economy has done well through value creation in resource-based industries, but it is stuck with those industries and it has not invested enough and developed capability in new industries.

On many occasions in this column, I have asserted that the main structural impediment to moving the economy to another level is the pervasive plantation logic. So long as resources are allocated to this sector — and there will be so long as it is profitable — there will be disincentives to move to new and riskier businesses. And the economy, which is not short of capital, does not create enough new firms in different areas.

The minister was quoted as saying that the reason for capping the expansion of plantation land is that Malaysia is committed to fulfil the pledge that half the country’s land area will be preserved as forests. That different departure point in her policy prescription does not change the conclusions reached here.

The effect is that existing firms will have to improve productivity if they want to increase output if both land and labour inputs in plantations are capped. They will be forced to innovate, and such technological innovation in a major economic sector will have a pervasive effect on the whole economy.

Various other fiscal incentives can be introduced to not only cap the area under plantations but to reduce it altogether, either by conversions into other smaller carbon footprint uses such as food production or outright reforestation as the ultimate trade-off. It all depends on the pricing mechanism of what is “green” and the various shades of green. At the very least, differential tax treatments can be accorded to companies depending on their shades of green — the kinds of activity they do to move away from plantations.

The greening of plantation land in this way can be akin to developing a commons of forest. The commons typically refers to the common grazing land in the Tragedy of the Commons proposed by ecologist Garett Hardin (1968), where users fail to develop governance and management structures to sustain the land as pasture. His solution was either privatisation or pure public ownership. The Europeans have developed various alternative models of governance that have managed forests as commons — interesting concepts and ideas that can now be seriously explored.

Legend has it that the Gordian knot was not untied, it was simply cut, by Alexander the Great no less. The irrationality of cutting this plantation Gordian knot is that, in the short term, it does not make financial sense. But once cut, it will be quite liberating and transformational. It is a bold solution to a complicated problem. My congratulations to the minister!


Dr Nungsari A Radhi is an economist and the views expressed here are not related to any of his organisational affiliations

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