Time to regain confidence
in economic integration
Integrating with the global market place was once
Indonesia’s offensive strategic choice to accelerate economic reform and
development. The country has benefited significantly from opening up to trade
and investment.
It responded without hesitation to plummeting revenues from
oil exports in the early 1980s with sweeping reforms to reduce tariffs,
non-tariff barriers, red tape in customs clearance and procedures for obtaining
business permits. These reforms spurred the expansion of light-manufacturing
industries and helped the economy reach a steady rate of per capita real income
growth of 5 per cent per annum until the Asian Financial Crisis in 1997.
Alongside domestic reforms, Indonesia was a champion of
economic integration and openness on the international stage. In the 1990s,
Indonesia led APEC’s Bogor Goals declaration and its leadership also helped
create the ASEAN Free Trade Agreement in 1995. As a member of the G20 process,
host for the 2011 ASEAN Summit and recent host of the 2013 APEC Summit,
Indonesia has supported old and introduced new initiatives
for economic cooperation, especially in regard to connectivity and
infrastructure. Indonesia is also one of the main advocates of the Regional
Comprehensive Economic Partnership agreement, one of the most ambitious trade
liberalisation vehicles currently being negotiated in Asia.
Yet today there seems to be growing caution towards greater
economic integration. In recent years regulatory and incentives regimes have
become more domestically oriented. Although Indonesia’s average import tariff
is relatively low at around 7 percent, many imports are subject to new
administrative requirements like pre-customs inspections and various permits.
The services sector has not become more open to foreign direct investment (FDI)
since 2003, with several areas remaining restricted to foreign participation.
Strict cabotage rules limiting the ability of foreign
providers to service Indonesian domestic sea lanes, combined with restrictions
on FDI in ports, warehousing, and freight forwarding, mean Indonesia’s logistics
sector is less exposed to competition than its main regional competitors. And
with the ASEAN Economic Community to be fully implemented in 2015, there is now
pressure on the government to protect domestic businesses and impose new
restrictive measures on trade and FDI.
The sentiments behind these policies are understandable.
Indonesia wants an equitable industrialization process led by Indonesian
entrepreneurs. The Indonesian economy is also sensitive to its current account
deficit, which gives the impression that its industrial structure is too thin
and dependent on imported goods and services. The trade balance is vulnerable
to commodity price shocks as more than half of its export value comes from
commodities and natural resources, whereas imports are mainly of capital goods
and intermediate products.
Indonesia needs to continue facilitating
industrialisation to move out employment that is currently concentrated in low
productive activities. Some argue that Indonesia should address these issues with
less exposure to international markets.
But these concerns are best addressed by pursuing structural
reform and taking advantage of further integration with the global economy.
Indonesia needs to generate business opportunities to absorb at least 2 million
new workers annually and position the economy to escape the middle-income trap.
This requires the economy to exceed the current growth trend
of 6 per cent per year, which will be difficult given the prevailing employment
growth rate and total factor productivity, and may require doubling investment
growth. Given that Indonesia’s gap between savings and investment is already
substantial and widening, the additional investment will have to come from an
increase in annual FDI inflow from its relatively low current value of 2
percent of GDP.
Rather than pursuing import substitution to slowly develop a
complete manufacturing base at home, Indonesia should participate more
extensively in regional and global manufacturing chains. This would allow
Indonesia to accelerate industrialization by taking advantage of natural
resource wealth, having FDI pay for capital in the form of factories off-shored
to Indonesia and leaving the nation free to focus on investing its own
resources in human capital and programs to facilitate local industries climbing
up the value chain where the value added is greater.
More openness could also substantially enhance productivity
growth. A 2007 study by Mary Amiti and Jozef Konings found that a 10 percentage
point fall in import tariffs on intermediate goods led to an average 11 percent
improvement in productivity for Indonesian firms that used those imports as
inputs, thanks largely to lower costs.
A separate 2009 study by Jens Matthias Arnold and Beata
Javorcik suggested that Indonesian manufacturing firms that received capital
and technology from FDI experienced, on average, a 13 percent productivity
increase in just three years. Exposing Indonesia’s retail, domestic air
transport and telecommunication sectors to greater international competition
has also been shown to lead to significant output growth with productive
spillover effects on the manufacturing sector.
Some domestic companies may indeed be unable to withstand
global competition or benefit from further integration. However, it would be
preferable for industrial policy not to protect the inefficient practices of
such businesses but to help them address their core constraints and improve
competitiveness.
A key issue in this regard is Indonesia’s relatively low
public spending on infrastructure and the high cost of doing business.
Indonesia must do more to reduce the cost of domestic freight, improve access
to energy sources and reduce bureaucracy and regulatory uncertainties so that
businesses can adjust rapidly to new opportunities. More competition in
backbone and bottlenecked services such as domestic sea freight, broadband
communication and energy distribution would help Indonesian businesses be more
cost competitive. There is also room for intervention to improve workers’ skills
and the capacity of local businesses to innovate.
Indonesia must regain its confidence in economic openness
and international integration. Exposure to international economic forces can be
difficult to manage at times but is critical for Indonesia to escape the
middle-income trap.
(Sjamsu Rahardja is Senior Economist at the World Bank
office in Indonesia. This appeared in the East Asia Forum)
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