The apparent increase in market concentration and vertical integration in the Indonesian
crude palm oil (CPO) industry has led to concerns about the presence of market power.
For the Indonesian CPO industry, such concerns attract more attention because of the
importance of this sector to the Indonesian economy. CPO is used as the main raw
material for cooking oil (which is an essential commodity in Indonesia) and it contributes
significantly to export earnings and employment. However, dominant producers argue
that the increase in economies of scale and scope lead to an increase in the efficiency,
which eventually will be beneficial for the end consumers and export earnings. This
research seeks to examine whether the dominant producers do behave competitively and
pass the efficiency gains to the end consumers, or they enhance inefficiency through
market power instead.
In order to identify the most suitable model to measure market power in the Indonesian
CPO industry, different market power models are explored. These models can be divided
into static and dynamic models. In general, all of them accept the price–cost margins as a
measure of market power. However, static models fail to reveal the dynamic behaviour
that determines market power; hence the dynamic models are likely to be more
appropriate to modelling market power. Among these dynamic models, the adjustment
model with a linear quadratic specification is considered to be a more appropriate model
to measure market power in the Indonesian CPO industry.
In the Indonesian CPO industry, producers can be divided into three groups, namely the
public estates, private companies and smallholders. However, based on their ability to
influence market price, smallholders are not considered as one of the dominant groups.
By using the adjustment cost model, the market power of the dominant groups is
estimated. The model is estimated using a Bayesian technique annual data spanning
1968–2003. The public estates and private companies are assumed to engage in a noncooperative
game. They are assumed to use Markovian strategies, which permit firms to
respond to changes in the state vector. In this case, the vector comprises the firms and their rivals’ previous action, implying that firms respond to changes in their rivals’
The key contribution of this thesis is the relaxation of the symmetry assumption in the
estimation process. Although the existence of an asymmetric condition often complicates
the estimation process, the different characteristics of the public estates and private
companies lead to a need for relaxing such an assumption. In addition, the adjustment
system—which can be seen as a type of reaction function—is not restricted to have
downward slopes. Negative reaction functions are commonly assumed for a quantity
setting game. However, the reverse may occur in particular circumstances. Without such
restrictions, the analysis could reveal the type of interaction between the public estates
and private companies. In addition, it provides insights into empirical examples of
conditions that might lead to the positive reaction function. Furthermore, the analysis
adds to the understanding of the impact of positive reaction functions to avoid the
complicated estimation of the asymmetric case.
As expected, the public estates act as the leader, while the private companies are the
follower. Interestingly, results indicate that as well as the private companies, public
estates do exert some degree of market power. Moreover, the public estates enjoy even
higher market power than the private companies, as indicated by market power indices of
-0.46 and -0.72, respectively. The exertion of market power by both the public estates and
the private companies cast some doubts about the effectiveness of some current policies
in the Indonesian CPO industry. With market power, the underlying assumption of a
perfectly competitive market condition—that serves as the basis for the government
interventions—is no longer applicable. Hence, many government interventions are
unlikely to have the desired effect.
The Indonesian competition law that has been imposed since 1999 might be effective in
preventing firms to sign collusive contracts. In fact, even without such an agreement,
firms in the CPO industry are likely to exert some degree of market power. As an
alternative, eliminating the ‘sources’ of market power might be a better solution. If the public estates have the aim of maximising welfare, privatisation might improve their
efficiency, hence they have ability to suppress the private companies’ market power.
However, if in fact, the public estates deliberately reduce output to gain higher profit,
privatisation might increase the degree of market power of both groups of companies
even further. In such a condition, addressing the long term barriers of entry stemming
from the requirement of high investment might be a better alternative to address the market power problem in the CPO industry.