Optimum Level and Welfare Effects of Export Taxes for Cocoa Beans in Indonesia: A Partial Equilibrium Approach

Aiming to support downstream processing, the Indonesian government announced an export tax in May 2010. Using a partial equilibrium approach, this paper therefore attempts to analyse: (i) whether the Indonesian government has imposed optimal taxes on cocoa beans; (ii) the impacts of cocoa export taxes on domestic welfare. In particular, it attempts to develop a two-stage partial equilibrium welfare analysis in which effects of policy for upstream sectors may affect downstream sectors. The study also presents thorough econometric estimates of import demand, export supply, Armington and cross elasticities using the Vector Error Correction Model (VECM) to deal with cointegration and simultaneity issues. A literature search suggests that existing studies not only report mixed results but also use methods, mostly the Ordinary Least Squares (OLS) model, which could not deal with cointegration and simultaneity issues. Three key lessons can be drawn for this study. First, an export tax on Indonesian exports of cocoa beans would indeed divert some of the crop to domestic use. However, this leads to significant losses to cocoa bean producers and does little to develop a processing sector. Second, interdependence between major cocoa exporting countries’ policy is evident. Third, due to limited readily available data, better econometric techniques do not necessarily lead to improved robustness of estimates of elasticities. This could significantly affect estimates of optimal export taxes and, therefore, analysis of welfare effects.