Wednesday, June 22, 2011

Three Things Indonesia Needs to Do To Start Competing With Regional Rivals

At the World Economic Forum in Jakarta this month, countries were urged to pursue increasing economic openness and competitiveness to drive new growth in Asia. For a country like Indonesia, which has concentrated on an ever-expanding domestic market, the forum was a timely call for a review of export policy, openness and competitiveness.

In some respects, the nation looks remarkably positioned to respond to such a call. The most recent WEF Global Competitiveness Report ranks Indonesia 44th in its overall index, behind Thailand at 38 and Malaysia at 26. The ranking is based on factors critical to a country’s capacity to produce competitive exports, particularly quality of infrastructure, technological readiness and human capital. Indonesia has managed to narrow the gap with Thailand and Malaysia since last year, climbing 10 places while its peers have fallen four places each.

In other ways, however, the picture is bleaker. Critics believe Indonesia lags behind in producing competitive exports in all three of the factors mentioned. Looking at these issues in more detail reveals why.

Export costs in all economies are influenced in part by the supply of relevant infrastructure. Inefficiencies stemming from a lack of roads, ports and electricity all increase production costs, thereby diminishing Indonesia’s ability to compete with its regional rivals with better infrastructure. Furthermore, these long-term problems deter potential future investors. This often can produce a vicious circle of underinvestment that can continue to hinder long-term expansion.

According to the World Bank’s 2011 Indonesia Economic Quarterly, current investment levels rival India’s, but there is a notable difference between Indonesia’s nominal and real investment due at least in part to the extra costs incurred as a result of infrastructure problems. If Indonesia is to supply competitive exports and reap the rewards of economic openness, it must invest in infrastructure to improve cost efficiency. In the 2011 Global Competitiveness Index, Indonesia ranks 82nd in infrastructure, thereby deterring foreign direct investment due to the consequent costs caused by port congestion, long travel times and unreliable delivery.

Still, infrastructure is but one element; technological readiness is another. Indonesia is not sourcing enough technological advances domestically, and is adding too little value to raw materials. While this is an issue in the short run, if Indonesia can always adopt technological innovations from foreign companies through FDI. The Harvard Kennedy School Indonesia Program has found that Indonesia needs to integrate into global supply chains for the same reason, as such networks are often coordinated at each level by multinationals willing to share their efficient production methods in order to reduce costs. This is particularly the case with regard to technological capacity, which is required in all export sectors to develop efficient production methods and reduce costs in a highly competitive global market. For technological competitiveness, the WEF Global Competitiveness Report ranks Indonesia 91st out of 139 countries. Of all of the relevant rankings, this is the country’s worst result.

The third criterion mentioned above is human capital. The low levels of skills and training for workers in Indonesia constrains the production of competitive exports. Indonesia is ranked 66th for higher education and training, and although it has achieved much success in improving enrollment rates at every level of education, it has focused on quantity (fueled by an education-for-all policy) while many people believe overall quality is declining. A lack of investment in tertiary education means the qualifications that the economy needs — science and engineering programs in particular, which are also the most expensive to teach — are in short supply. This is at a time when China is producing 300,000 engineering graduates a year.

In summary, it does not take an economic genius to see that the relative low ranking for all three criteria shows Indonesia is not really competitive relative to rival countries, even within Asean.

Furthermore, what happens with investment today will have an immediate impact on investment in the future. Even if Indonesia was able to aggressively and immediately begin fixing the necessary changes in infrastructure development, technological change and human capital improvement, the reality is that all of these issues have a long gestation period.

At the same time, the reality is that to attract FDI now, changes also need to happen immediately to deter foreign companies looking for superior investment climates elsewhere. According to the Indonesia Economic Quarterly, gross FDI inflows in 2010 were the highest since the 1997-98 crisis, which is a good sign, but still remain lower relative to GDP than pre-crisis peaks and relative to many regional peers. Indonesia has a long way to go to maximize its potential for FDI. Any role that exports can play in FDI will be a positive one.

But given its vast domestic market, should Indonesia even worry about exports? The answer must surely be that all aspects of the economy are equally important. Economies are rarely about one or the other. Inflationary pressures can very quickly dampen consumer confidence, and rising prices — both external and internal — can equally quickly erode domestic markets for many consumer goods, putting pressure on the overall economy and devaluing this asset very quickly.

Overall, Indonesia is fiscally in good shape. The government’s finances are in order, the exchange rate is high and balance of payments surplus considerable and international reserves have been increasing steadily. Many economists believe that Indonesia is too fiscally prudent and could stimulate the economy even further by loosening its purse strings a little. One culprit of underinvestment is underspending: Although provisions are made in the budget for appropriate expenditure, these are often not fully realized. The Ministry of Public Works and the Ministry of Health were among the main underspenders in 2010.

Indonesia has achieved impressive rates of growth in recent years. Imagine then what it could do if it were to boost its standing in the export market. Net exports are already one of the main drivers of Indonesia’s considerable growth, which reached 6.1 percent in 2010, and are therefore of great importance to the economy. While Indonesia should not overlook this means to furthering development, especially if it wishes to maintain its near 7 percent growth rate, it would be wrong to suggest that exports will be Indonesia’s economic development savior. Indeed, much of why Indonesia was saved from the most recent economic crisis was its isolation from export markets and external influences entwined within them.

But Indonesia could boost export growth even further and develop advantages that would sustain growth for years to come. To make this growth all the more meaningful, exports would need to be more competitive. As Indonesia improves its infrastructure capabilities, technological readiness and human capital, so too will its competitiveness improve.

By Kate O’Loughlin associate researcher at Strategic Asia Indonesia, a Jakarta-based consultancy promoting cooperation among Asian nations.

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