Transaction Costs and Agrarian Institutions in Indonesia: the Case of Cianjur District

Abstract: The basic question underlying this paper is why do inefficient institutions persist in paddy rice market in Indonesia. The problem of market failures in paddy rice market is indicated by the wide price margins between the low sale price at which farmers sell the commodities or factor and the high purchased price at which they could buy the products or factors. Some literature suggested the role of inefficient agrarian institutions, such as the middlemen and sharecropping, to this issue. The middlemen’s margin contributes to the wide margin and causes the household farmers to hardly get a fair pricing for the products. Meanwhile, sharecropping has been claimed to bring losses to farmer’s welfare. With the help of Transaction Costs Economics and Economics of Governance approaches, that suggest that markets may fail due to the high transaction costs associated with using the market mode, which leads the agents to conduct transactions through institutional arrangements other than the market, this paper analyzes how do household farmers deal with the existing transaction costs in paddy rice market. Using a household model with market failure, this paper compares the level of efficiency in terms of net income between modes of governance in paddy rice production. This paper found that paddy rice farmers get benefits from institutional arrangements available due to the role of middlemen and sharecropping institutions, which obtained through private ordering. Meanwhile, a government intervening institutional arrangement, the association of farmers group, has brought no significant benefit to farmers. These findings give a highlight to the understanding of why such inefficient institutions, the middlemen and sharecropping, remain as the widely prevalent agrarian institutions.